In 2009, when cryptocurrency (“crypto”) emerged, it raised many questions among investors and the accounting community alike about how to tax it, as it was a novel concept. Since then, the Internal Revenue Service has released guidance that clarifies the proper treatment, including what constitutes a taxable event when dealing with crypto. In this article, we delve into the world of cryptocurrency taxation and provide some examples.
How the IRS Views Crypto
Cryptocurrency is unique from other currencies in many ways, including that it does not exist in a physical form. It is not considered a traditional currency or legal tender by most governments, including the US. Because its classification is unique, it is often viewed as a distinct asset class. In 2014, the IRS ruled that cryptocurrency, also known as “digital assets”, should be treated as property for tax purposes and subject to capital gains tax.
It is helpful to understand which types of crypto transactions give rise to taxable events. The good news is that buying crypto for cash is not a taxable event. When individuals receive crypto as payment for goods or services, it generates taxable income for the recipient, which is taxed at ordinary income rates. The recipient’s taxable income is equal to the fair market value of the crypto at the time he or she received it.
Selling crypto for cash is also a taxable event, giving rise to a capital gain or loss. Similar to stock and other capital assets, the amount of time you hold the crypto affects your tax liability. If you hold it for over a year before selling or exchanging it, you’ll classify any resulting gain as a long-term capital gain, subject to preferential tax rates. If you hold it for less than a year, any resulting gain is short-term and taxed at ordinary income rates. You calculate your gain or loss by finding the difference between the selling price and the fair market value of the crypto when you initially acquired it.
To illustrate, assume Contractor A performs services for Company ABC. On November 30, 2023, Company ABC pays Contractor A 1 Bitcoin. Contractor A holds the Bitcoin until she sells it on February 10, 2024 for $39,000 cash. When she received the Bitcoin on November 30th, its fair market value (i.e., what it was trading for on that date) was $37,000. The first taxable event occurred in 2023 when she received payment for her services. On her 2023 tax return, Contractor A would report $37,000 of ordinary income. The second taxable event occurs on the sale date. On her 2024 tax return, Contractor A would report $2,000 of short-term capital gain.
Other Crypto-Related Events That Result in Taxable Income Include:
- Using crypto to buy another asset: If Contractor A had used her Bitcoin to purchase a car worth $39,000 on February 10th instead of selling it for cash, she would still recognize $2000 of short-term capital gain.
- Mining crypto: As we described in our article about the upcoming Bitcoin halving event, mining refers to the process of creating crypto using strong computing power. Tax authorities apply ordinary rates to tax the value of mined coins.
- Staking crypto: Staking is the process of providing, and thus temporarily locking up, crypto you own to help support the blockchain validation process. In exchange, you receive a payment similar to interest. It is taxable income.
Trading One Crypto For Another
Things become a little more complicated when you exchange one type of cryptocurrency for another. Exchanging cryptos is a taxable event, and the seller must determine how much he or she gained or lost in US dollars by looking at the relative fair market values of each crypto in US dollars on the dates acquired and sold. Therefore, you need to track the fair market value of each crypto you own on the dates you purchase, exchange, or sell it.
Calculating and Reporting
There can be a lot of detailed information to track for a business owner who receives multiple payments in crypto or an investor who executes many crypto trades. There is software available to track this information, and some crypto trading platforms maintain and send it, but many still do not. If you do not receive a tax form from a crypto trading platform, but you sold or exchanged crypto during the year, you are responsible for gathering the information needed to calculate and report your taxable gain or loss. You report capital gains or losses on Form 8949, the same tax form used for reporting capital gains and losses on stock trades.
Seeking Professional Guidance
With the detail and complexity involved in calculating any tax liability resulting from crypto transactions, it may make sense to work with a tax professional who understands digital assets. Keeping detailed records can also help you comply with reporting requirements. Our experts at MyCPA are ready to help provide personalized advice for your tax situation. Visit our Get In Touch page to schedule a consultation.