If you have purchased, owned, sold, gifted, made purchases with, or used cryptocurrency in business transactions, there are certain tax issues you need to know about. Unfortunately, there are some unanswered questions and little specific guidance offered by the IRS other than in Notice 2014-21 and Revenue Ruling 2019-24. This article includes the guidance from the Notice as well as general tax principles that apply.
One of the big issues of cryptocurrency is how it is treated for tax purposes. The IRS says that it is property, so that every time it is traded, sold, or used as money in a transaction, it is treated much the same way as a stock transaction would be, meaning the gain or loss over the amount of its original purchase cost must be determined and reported on the owner’s income tax return. That treatment applies for each transaction every time cryptocurrency is sold or used as money in a transaction, resulting in a major bookkeeping task for those that use cryptocurrency frequently.
Example A: Taxpayer buys Bitcoin (BTC) so he can make online purchases without the need for a credit card. He buys a partial BTC for $2,425 and later uses it to buy goods worth $2,500 (let’s say the partial BTC was trading at $2,500 at the time he purchased the goods). He has a $75 ($2,500 – $2,425) reportable capital gain. This is the same result that would have occurred if he had sold the BTC at the time of the purchase and used cash to purchase the goods. This example points to the complicated record-keeping requirement for tracking BTC’s basis. Since this transaction was personal in nature, no loss would be allowed if the value of BTC had been less than $2,425 at the time the goods were purchased. Of course, if the taxpayer in this example only sold a fraction of his Bitcoin – say enough to cover a $500 purchase – the gain would only be $15: $500/$2500 = .2 x 2425 = 485; 500 – 485 = 15.
On the bright side, for most individuals, cryptocurrency is generally treated as a capital asset, so any gain is a capital gain, and if the asset is held for more than a year, any gain will be taxed at the more favorable long-term capital gains rates. If the cryptocurrency is being held as an investment and the sale results in a loss, then the loss may be deductible. Capital losses first offset capital gains during the year, and if a loss remains, taxpayers are allowed a $3,000-per-year loss deduction against other income, with a carryover to the succeeding year(s) if the net loss exceeds $3,000.
If you don’t understand how cryptocurrencies function here is a brief explanation.
For tax purposes the IRS in their guidance have determined that miners are operating a trade or business and the value of the cryptocurrency earned (determined in U.S. dollars at the time of the transaction) is included in the gross income of that business. The business’ profit is treated the same as it is for any other business – taxed as ordinary income and subject to self-employment tax.
Example - An individual mines one Bitcoin in 2020. On the day it was mined, the market price of a Bitcoin was $10,000. The miner has $10,000 of business income in 2020 subject to both income tax and self-employment tax. Going forward, the basis in that Bitcoin is $10,000. If the miner later sells it for $12,000, there is a taxable capital gain of $2,000 ($12,000 − $10,000).
Here is some guidance that applies to specific issues:
o This also results in a larger donation because, instead of paying capital gains taxes, the charity will receive the full value of the donation.
To further the IRS’ efforts to flush out taxpayers who may have cryptocurrency reporting requirements, a Yes/No question has been included on Form 1040 asking taxpayers whether they received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency during the tax year. When signing their return, a taxpayer attests under penalties of perjury to have a “true, correct and complete” return. Taxpayers who answered the cryptocurrency question “no,” and the IRS finds that they actually had reportable virtual currency transactions, could be subject to significant penalties.
If you have questions related to your involvement with cryptocurrency, please book a consultation!
C&A Financial Services
One-stop for all your financial service needs.