This year we will we will begin noticing just how hot of a topic cryptocurrency is becoming with the Feds and the IRS. If you own, exchange, or invest in digital currency (Virtual Currency as of 2019's income tax forms) you will be seeing a box on this year's individual tax returns that asks: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
In the U.S., virtual currency (VC) transactions are treated as "property" and taxable by law just like transactions in any other type of property. Taxpayers transacting in virtual currency now have to report those transactions on their tax returns. According to the IRS: "The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability." Any gain or loss on sale is capital in nature and reported on Schedule D, the same way as is done for stocks.
To break down the scenarios you will be dealing with this year, I have listed below some of the options that may apply to your filing needs:
Asset Acquisition
Purchase: If you purchased any VC with regular currency, the cost basis is simply the amount paid, that means no further income tax reporting is needed.
Exchange: If the VC was received in exchange for goods or services, the basis is the fair market value of the VC, if traded on an exchange. Otherwise, the basis is the fair market value of the goods or services provided. In an exchange transaction, the receiver of the VC reports it as income in the same way as if the transaction occurred with regular currency.
Gift/Inheritance: Treated the same way as receiving a gift or inheritance of any other property, including disclosures if received from a foreign party.
Hard Fork: The acquisition of VC in a hard fork results in ordinary taxable income equal to the fair market value of the VC received.
Mining: Mining income is treated as ordinary income again based on the fair market value of the VC received. This is your straight-forward Schedule C (income from self-employment) so it is important to list all deductions such as electricity, hardware, office space, etc. Take an extra note on this: mining income could be subjct to self-employment tax and, which allows you to establish and contribute to a retirement plan based on the net profit from all mining activity.
Asset Disposition
Sale: Gain or loss is the difference between the fair market value of the VC sold and its cost basis. Whether sold for legal tender or used as payment for goods or services, the transaction is reportable and your profits are taxed.
Donation: A major concern for potential donors of virtual currencies. If the VC is held for less than one year, the charitable contribution deduction is the smaller of its cost basis or its fair value on the date of donation. If held for more than one year, the deduction is the fair market value on the date of donation. However, unlike stock, which does not require an appraisal, a value of over $5,000 requires an appraisal.
The IRS requires a qualified appraisal for donated property over $5,000 in value. Although there is an exception for publicly traded securities, it doesn't look likely that the Service would deem virtual currency to be "qualified appreciated stock." To explain this further, it defines a “publicly traded security” as one that is “listed on a stock exchange in which quotations are published on a daily basis,” or “regularly traded in a national or regional over-the-counter market for which published quotations are available.” Although there are online virtual currency exchanges, they are very clearly not stock exchanges, and as such do not qualify under the first category. The second category is a closer case, because although traders can easily locate price information about virtual currencies online, it is difficult to say that virtual currencies fit within the sort of market described. As such, VCs are probably not within the IRS definition of “publicly traded security” for non-cash donation purposes.
Gift: Because the VC is property, the same rules apply. The giver does not recognize any gain or loss on disposition but may be required to file a gift tax return.
The IRS also provides two clear choices for basis calculation:
Specific identification: Cost basis for each batch of VC is determined upon acquisition, meaning that once disposed of, you will identify the particular batch or batches of VC. The advantage of this method is that you can pick high basis coins that are sold for cash, as well as low basis coins that are donated or gifted.
FIFO: Dispositions of VC are first in, first out. You have no control over basis and you could be forced to recognize income that could have been avoided or reduced using specific identification.
I can not stress enough the importance of record keeping in all your crypto endeavors to help you with filing your tax returns. Tax auditing follows the same exact protocol with digital currency as it does with everything else.
For further reading and to ensure you are filing your crypto gains and losses in accordance with the new laws, please visit:
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