If you are a cryptocurrency investor or receiving payments for your products or services in cryptocurrency, be aware that cryptocurrency transactions are under the radar of IRS now more than ever. Before getting into the topic, let’s define cryptocurrency.

For federal tax purposes, cryptocurrency is a virtual currency and treated as property. It’s not treated as currency that could generate foreign currency gain or loss. General tax principles applicable to property transactions apply to transactions using virtual currency.

Crypto taxes are like taxes on stocks. If you sold crypto at a profit, you’ll owe short-term or long-term capital gain taxes. It’s calculated with following formula.

Capital Gain/Loss = Value at time of sale – Cost Basis

Buying, Selling, or Exchanging Crypto

Buying only: If you bought Bitcoin at $5,000 and its value went up to $45,000, you do not owe any taxes until you sell your Bitcoin.

Buying and selling: Let’s say you bought Bitcoin at $15,000 and sold it after it rose to $45,000. Your gain is $30,000, and you will owe capital gain taxes on that income. If you sell your crypto for loss, you may also be able to claim your losses to offset other gains.

Exchanging crypto for crypto: Converting cryptocurrency is taxable. Let’s say you traded your Bitcoin with Ethereum, it’s considered as selling your crypto and purchasing another even if no cash changes hands.

Wallet to wallet transfer: Transferring crypto between wallets is not a disposition therefore is not taxable.

To report your gains and losses you need the details of your transactions. Some companies provide you 1099-B forms some don’t. It’s your responsibility to gather and organize your transactions. You can integrate or use third party apps to report your cryptocurrency transactions.

Gifts and Charitable Contributions in Cryptocurrency

Gifts

If the fair market value of the cryptocurrency is less than $15,000, cryptocurrency gift is not considered a taxable event and does not need to be reported on your tax return. If the value of cryptocurrency gift with a fair market value is more than $15,000, you will be required to fill out a gift tax return (IRS Form 709).

Charitable Contributions

If you donate in cryptocurrency to a qualified charitable organization, you are not liable for tax on the asset, and you can have a charitable contribution deduction. If you held the donated crypto for more than a year, then the deduction amount is equal to the fair market value of the crypto donated.

For example: you bought a coin for $500, waited more than a year and donate it when it’s worth $10,000. You get a $10,000 deduction without having to pay tax on the $9,500 gain.

If the crypto is held for under a year or less, you are still eligible for a deduction, but the deduction amount is the lesser of the crypto’s cost basis or fair market value.

Airdrops

An airdrop is the random distribution of coin or tokens to a variety of wallet addresses during a marketing effort free of charge. Receiving cryptocurrency via an airdrop is ordinary income and you must report the income on your tax return.

Crypto Mining

Income from crypto mining is considered ordinary income and may be subject to self-employment tax if you’re mining as a trade or business. When you successfully mine crypto, the fair market value of the virtual currency as of the date of receipt is includible in gross income.

Buying Stuff with Crypto 

If you use crypto to buy something, the IRS considers that as sale of your crypto. You must calculate gain or loss. You might have bought something with your crypto however you made a sale in the process even if you didn’t get the cash in your hand.

As an example, let’s say you purchased one Bitcoin for $10,000, Bitcoin value went up to $45,000. You bought a car for $45,000 and paid in Bitcoin. A gain of $35,000 would be reported as capital gain.

Getting Paid in Crypto

If you’re paid in crypto for performing a service or selling physical products, you must report this income in your tax return. Any payments received in the forms of crypto mining, staking, airdrops, and earning interest on your crypto deposits are taxable and subject to income and/or self-employment tax.

Tracking Your Crypto Transactions for Accounting

Let’s say you buy 6 bitcoins at $3,000 and 6 more at $8,000. Couple of months later you sell one coin for $15,000. How much is your gain? Is it one of the early ones creating a $12,000 gain or one of the late ones creating a $7,000 gain?

According to IRS you have two options.

1. First in first out: The first coin that you purchase (chronologically) is the first coin that is counted for a sale. However, this may give you a higher tax bill.

2. Specific identification: Last in first out (LIFO) or Highest in first out (HIFO) are two methods that can be used. These methods enable you to select that minimizes your tax bill (usually, the cryptocurrency with the highest purchase price).

Conclusion

If you are trading crypto, you must keep the taxes in mind. Crypto taxes are complicated, new crypto investors should understand the basics of cryptocurrency taxes before they start investing. We hope you found some answers about the basics of cryptocurrency taxes in this article. If you have additional questions or need help preparing your crypto tax return, do not hesitate to contact us, we’d be happy to help!

References;

IRS Notice 2014-21
https://www.irs.gov/pub/irs-drop/n-14-21.pdf
IRS Rev. Rul. 2019-24
https://www.irs.gov/pub/irs-drop/rr-19-24.pdf
Publication 544, Sales and Other Dispositions of Assets
https://www.irs.gov/forms-pubs/about-publication-544
Publication 525, Taxable and Nontaxable Income
https://www.irs.gov/forms-pubs/about-publication-525
Frequently Asked Questions on Virtual Currency Transactions
https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
Virtual Currencies
https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies

Disclaimer
This article is intended for informational purposes and should not be taken as legal or tax advice. You must consult with your tax, financial or legal adviser about your unique financial situation before acting on anything discussed in this article. TaxBasket LLC is providing informational content for general guidance to help small business owners become more aware of certain issues and topics and this article must never be considered as a substitute for advice provided by your tax, financial or legal advisers. TaxBasket LLC or its members cannot be held liable for any use or misuse of this content.