Cryptocurrency has made a lot of headlines since its inception in 2009 and, regardless of your opinion of it, there’s no denying its recent surge in popularity. According to a Gemini crypto report issued in April 2021, approximately 21.2 million adults in the U.S. own cryptocurrency. Unfortunately, many of these crypto owners don’t fully understand the tax consequences of their investment. Some consider their investment in cryptocurrency as a tax-free loophole falling outside the realm of the Internal Revenue Code, a “hidden treasure,” if you will. The IRS recently addressed this flawed public belief by deploying the appropriately-named initiative Operation Hidden Treasure. The new initiative includes training IRS agents in the field of virtual currency and cracking down on taxable crypto transactions. Here are some guidelines for taxpayers to correctly report virtual currency activity:
When buying and selling cryptocurrency, it’s easiest to understand the tax consequences by imagining you’re buying and selling stock. Let’s say you bought one Bitcoin for $1,000 in 2017 and sold your Bitcoin in 2021 for $30,000. Your proceeds ($30,000) less your basis ($1,000) would result in a $29,000 long-term capital gain, just like selling a share of stock. You then need to record the transaction on Schedule D of your tax return, also just like selling a share of stock.
Brokerage companies usually issue Forms 1099-B to its customers when they buy and sell stock on their platform. The 1099-B lists the proceeds and the basis from the sale of the security, making it easy for the taxpayer to record the transaction on his or her return. While some cryptocurrency exchanges issue its users 1099-B’s, many of them, unfortunately, do not. Therefore, it’s important to keep track of the date and purchase price of when you buy cryptocurrency.
When using cryptocurrency to purchase something from someone, a capital gain or loss is calculated almost the same as if the crypto was sold on an exchange. Instead of recording the cash received as the proceeds, the fair market value of the item purchased is used as the proceeds. For example, you buy one Bitcoin for $1,000 in 2017 and wish to use that Bitcoin to purchase a new car that’s worth $30,000. Assuming the dealership accepts Bitcoin as a payment, you trade your one Bitcoin for the car. Your proceeds ($30,000 FMV of the car) less your basis ($1,000) would result in a $29,000 long-term capital gain.
Getting paid with cryptocurrency for services or products you’ve provided is taxable. The crypto compensation is treated as ordinary income, just as if you had received cash. For example, if your employer paid you one Bitcoin on November 15th, your taxable income would be the fair market value of the Bitcoin on November 15th. If you are an independent contractor, you must also pay self-employment tax on the cryptocurrency. Consider the previous example, except you are an individual contractor instead of an employee. Your income tax would be calculated the same, but you would also calculate self-employment tax based on the fair market value of the Bitcoin on November 15th.
In general, cryptocurrency doesn’t offer many special tax benefits. The only noticeable tax benefit of cryptocurrency is its exemption from wash sale rules. The exemption occurs because the IRS doesn’t consider cryptocurrency a security, such as a stock, bond, etc. This means cryptocurrency can be bought within 30 days before or after it is sold at a loss, and the loss will still be deductible for tax purposes.
Cryptocurrency transactions can become more complicated than the scenarios above. When they do, it is best to contact a professional at Mahoney for guidance on how to address your situation.