Virtual currency transactions are taxable by law, just like transactions of any other property. The IRS recently issued new cryptocurrency guidance and will be hot on your trail if you bought and sold cryptocurrency without reporting it.
Here are the tax basics. Cryptocurrency will be treated as property for tax purposes if you:
- Receive bitcoin in exchange for your services, your income is the fair market value of the bitcoin received plus any transaction fees incurred.
- Receive bitcoin in exchange for property, your gain or loss is the fair market value of the bitcoin received plus any transaction fees incurred, less the adjusted basis of your property given up.
- Give bitcoin in exchange for services, the value of the expense is the fair market value of the bitcoin given. The value of the services received less the adjusted basis of the bitcoin is a gain or loss to you.
- Give bitcoin in exchange for property, your gain or loss is the fair market value of the property you received less the adjusted basis of your bitcoin.
As long as you aren’t a trader, cryptocurrency is treated as a capital asset. Therefore, you will pay tax on any gain at reduced rates, and any losses are subject to capital loss limitation rules.
A fork occurs when the digital register that logs transactions of a particular cryptocurrency diverges into a new digital register. There are two types of forks:
- One in which you don’t get cryptocurrency, and;
- One in which you will receive new cryptocurrency.
The IRS ruled that a fork in which you:
- Don’t get cryptocurrency is not a taxable event, and;
- Do receive new cryptocurrency is a taxable event, and you’ll recognize ordinary income equal to the fair market value of the new cryptocurrency received.
Example. You own J, a cryptocurrency. A fork occurs and you receive three units of K, a new cryptocurrency. At the time of the fork, K has a value of $20 per unit. You’ll recognize $60 of ordinary income due to the fork.
When selling property, you generally sell it on a first-in, first-out (FIFO) basis, unless you are eligible to use the specific identification method. Use the specific identification method if possible because you can select the amount of gain or loss your sale will create. With FIFO, you have no choice.
To use the specific identification method, you’ll need to document the particular unit’s unique digital identifier, such as a private key, public key, and address, or keep records showing the transaction information for all units of a specific virtual currency–such as bitcoin–held in a single account, wallet, or address.
This information must show:
- The date and time you acquired each unit;
- Your basis and the fair market value of each unit at the time you acquired it;
- The date and time you sold, exchanged, or otherwise disposed of each unit;
- The fair market value of each unit when you sold, exchanged, or disposed of it, and;
- The amount of money or the value of property received for each unit.
The value of virtual currencies is trending upward at a remarkable place. Be assured, Uncle Sam is making it crystal clear that crypto transactions require reporting. As always, if you have any questions, please contact me.