Cryptocurrencies, including Bitcoin, Dogecoin, and other virtual currencies, have been in the news a lot lately. Whether you’ve heard that now is the time to buy or been warned about a crash, anyone who buys, earns, trades, or sells crypto needs to understand the tax consequences.
Starting with 2020 tax returns, the IRS moved the question, “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” to the top of Form 1040. While the question itself isn’t new—a similar question appeared at the top of the 2019 Schedule 1—its move to the front of Form 1040 indicates the IRS’s growing focus on cryptocurrency tax compliance.
Let’s look at seven things you should know about cryptocurrency and taxes.
1. Cryptocurrency is treated as property for tax purposes
Many people think of cryptocurrency as an alternative to cash, but according to IRS Notice 2014-21, the Internal Revenue Service (IRS) considers cryptocurrency to be property rather than currency for federal income tax purposes. Buying cryptocurrency isn’t a taxable event, but selling it for more than you paid for it creates taxable capital gains under United States tax law.
This gives crypto investors an opportunity. If you hold onto your coins for more than one year, you can benefit from lower long-term capital gains tax rates, which range from 0% to 20%. Short-term capital gains—those on crypto held for one year or less—are subject to the same tax rates you pay on other types of income: 10% to 37%, depending on your federal income tax bracket.
2. Wash sale rules don’t apply to crypto taxes—for now
The IRS’s wash sale rules prohibit investors from selling securities at a loss to claim capital losses on a tax return, only to rebuy the security within 30 days. The IRS will not allow you to claim the loss if you have a wash sale. Instead, the loss increases the cost basis of the replacement security.
Currently, wash sale rules don’t apply to cryptocurrency assets, so it’s possible to take advantage of this loophole for crypto tax loss harvesting. However, the regulatory landscape for crypto is changing, so that could change soon.
3. Crypto received as payment for goods and services is taxable income
You also owe taxes on crypto if you receive it as payment for goods or services. In this case, it’s taxed at your ordinary income tax rates, based on the fair market value of the coins on the day you received them.
4. Interest earned on digital currency is taxable
Many cryptocurrency exchanges offer interest-bearing accounts. Instead of paying interest in fiat currency, account holders receive interest payments in the same digital assets used to fund the account. You can either hold this interest and further invest it or sell it for fiat currency when you receive it.
Receiving interest payments in cryptocurrency is not treated like traditional interest earned from a bank account. Again, since the IRS sees cryptocurrency as a capital asset, you’re taxed on the asset’s fair market value on the day you receive it. You need to report it as miscellaneous income on your federal income tax return.
If you later dispose of the crypto by selling, swapping, or spending it, any profit will also be subject to capital gains taxes.
5. A “hard fork” of a cryptocurrency may create taxable income
A hard fork in cryptocurrency refers to a radical change to the protocol of the cryptocurrency’s blockchain that requires all validators in a network to upgrade to a newer version. This effectively leads to a permanent chain separation as the older version is no longer compatible with the new version. Anyone holding tokens on the old chain is also granted tokens on the new one.
In 2019, the IRS released Revenue Rule 2019-24, which ruled that a taxpayer who owns a cryptocurrency that undergoes a hard fork has taxable ordinary income if:
- The hard fork results in a new cryptocurrency, and
- The taxpayer actually or constructively receives the new cryptocurrency.
On August 1, 2017, Bitcoin experienced a hard fork that resulted in Bitcoin owners receiving Bitcoin Cash on a 1:1 ratio.
The IRS’s Chief Counsel Advice (CCA) Memo No. 202114020 confirmed the tax treatment of virtual currencies as property and clarified the IRS’s position for taxpayers who held Bitcoin at the time of the hard fork.
If you own cryptocurrency at the time of a hard fork, failure to report the income could subject you to penalties and interest, so it’s a good idea to review your tax positions.
6. Good recordkeeping is critical
The Infrastructure Investment and Jobs Act, signed into law in November 2021, included tax reporting provisions that apply to digital assets. Starting in 2024, cryptocurrency brokers will need to report cryptocurrency transactions on a 1099-B form.
You may be familiar with Form 1099-B, which reports capital gains and losses from securities. Securities brokers send a copy of your 1099-B to you and the IRS at the end of each year, reporting your proceeds, cost basis, and associated gains or losses. You use Form 1099-B to report capital gains and losses on your tax return, and the IRS uses it to verify that you reported the income correctly.
Until this new reporting requirement goes into effect, recordkeeping is up to cryptocurrency owners. Calculating your gains and losses may be simple if all your cryptocurrency transactions take place on one exchange. Most exchanges can provide a transaction report that includes the transaction type, proceeds, and fees. However, these reports may not include information on your cost basis.
Cryptocurrency wallets may or may not support transaction reporting. If yours doesn’t you may need to rely on screenshots, spreadsheets, or cryptocurrency transaction tracking software to document your gains and losses.
7. Cryptocurrency reporting requirements for businesses
The Infrastructure Investment and Jobs Act also requires businesses that receive cryptocurrency worth more than $10,000 in a single transaction to report the transaction, including the name, address and tax identification number of the person from whom the cryptocurrency was received, to the IRS on Form 8300.
Form 8300 is already familiar to many cannabis companies and in other industries that handle large cash transactions. However, this may be a new form for non-cannabis business owners and individuals that make large cryptocurrency transactions.
The Form 8300 filing requirement may be triggered by a single transaction of $10,000 or more, as well as multiple payments totaling $10,000 or more. Businesses that fail to file Form 8300 may be subject to civil and criminal penalties.
Businesses should consider creating an internal policy to ensure that Form 8300 is filed on any qualifying transactions. In addition, it’s helpful to work with a tax advisor who can help guide you through the reporting process and help you plan for the future—especially as cryptocurrency regulations evolve. If you need help, please get in touch with your AB FinWright advisor. We’d love to help make filing cryptocurrency taxes a bit easier.