An NBC survey found that out of 1,000 Americans, 21% had used cryptocurrency in some form. With cryptocurrency’s growing ubiquity from the NFL to Gucci, this number seems likely to go up. Apps like Robinhood and Coinbase have increased the accessibility of this new asset, introducing cryptocurrency to a general public that might be ignorant of its tax implications. Ignorance isn’t bliss when the IRS shows up at your door; keep reading to keep yourself informed.
How is the Income on Cryptocurrencies Taxed?
Unlike stocks, bonds, and real estate, there is no income on cryptocurrencies; you only pay tax on it when it’s traded, exchanged, mined, or received as compensation for income.
On the tax return, the IRS will ask the following:
“At any time during the year, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
Your answer hinges on the type of transaction you had with cryptocurrency.
There is no implication when you merely purchased it.
Mark yes…
- If you received it as payment for goods or services.
- If you received virtual currency as a transfer of another virtual currency
- If you received virtual currency for free without providing consideration, i.e. a gift (you still must mark yes and report it, even though there is no tax implication)
- If you received virtual currency as a result of mining
- If you exchange virtual currency for a virtual currency, property, or for goods and services.
- If you sold virtual currency.
- If you had any type of disposition of a financial interest in virtual currency.
How is Cryptocurrency or the Transactions of Cryptocurrency Reported to the IRS?
Apps like Coinbase, Robinhood, and PayPal are required to report transactions to the IRS.
Do I Owe Tax if I Exchange One Virtual Currency for Another?
Yes. In this exchange, you sell an asset and use that profit to purchase another. The IRS may consider this a taxable transaction.
If you trade Bitcoin for Ethereum when the former is at $1,000 and trade it back when Bitcoin is at $1,200, the $200 capital gain is taxable.
Can I do a 1031 on my Virtual Currency?
No. The 1031 exchange involves exchanging one property for another. You cannot exchange virtual currency for real estate, because virtual currency is not a real property.
Can I donate my Cryptocurrency to Charity?
Yes, if it is to a tax-exempt organization- and you can get a tax deduction for the donation. However, you might not want to donate it unless it has significant appreciation- if its value depreciates, you can deduct it as a loss from your tax return.
How do I record a cryptocurrency or a virtual currency transaction on my tax return?
Record your donations just like a regular cash contribution or a non-cash contribution on Schedule A of your tax return, and itemize your deductions.
If you sold, transferred, or purchased anything with cryptocurrency, fill out a form 8949 and Schedule D, the same form you would complete if you sold stocks, bonds, or real estate.
If you are paid in virtual currency, you need to complete Schedule C: non-employee compensation. If you receive it as compensation, you have to pay a payroll tax on it- even if you don’t sell it.
An employer who pays in virtual currency also must pay payroll tax, which is only payable in US dollars.
If you receive virtual currency for rent or royalties or any type of partnership income, you have to file Schedule E. If you do so, be aware of loss limitations. This applies to those with passive activities like rental properties or investments.
What if I own a business that receives cryptocurrency as payment?
If you receive cryptocurrency as payment for goods or services, it is the same as if you earned U.S. dollars. Report income at the fair market value of the currency at the time of payment. You don’t pay capital gain taxes until you sell that virtual currency and use it to buy something else. For example, if you receive currency at the fair market value of $10,000 and sell it at a value of $11,000, you will pay capital gains taxes on the $1,000 difference.
What if I’m a miner?
Miners of cryptocurrency have to report income for the fair market value at the time of receipt.
What will happen if I don’t report the virtual currency transaction on my tax returns?
The IRS is cracking down on both recipients and brokers of virtual currencies, contacting websites like Robinhood and Coinbase to collect user data.
The IRS will send one of three notices.
Be on alert for Letter 6173. This one’s no joke- it means the IRS knows you made unreported virtual currency transactions, and they want documentation explaining why. This letter is serious, so make sure to respond ASAP.
Letter 6174 is less threatening than the 6173, but shares its urgency. The IRS thinks you made virtual currency transactions, and they want you to review your tax return and determine whether you need to make an amendment.
Letter 6174 A is similar to letter 6174. The difference is that the IRS tells you they might engage in additional correspondence, asking for more documentation.
The last notice is the CP2000 notice. The IRS has received information on what you reported and they received what you’ve reported, but there’s a discrepancy. This notice asks for an explanation with documentation.
Final Thoughts
Cryptocurrency gets cryptic. It often seems like a different language, and in many ways it is. With the IRS cracking down on virtual currency and tracing activity across popular applications like CoinBase and RobinHood, you won’t want to get lost in translation- or you’ll get lost in taxation. Keep yourself on the right track by following the guidelines listed above, and you’ll be able to have your crypto and eat it too.
Looking for an independent fiduciary financial advisor who can advise you on investments, retirement, real estate, alternative assets, and taxes? Contact ACap Advisors & Accountants to schedule a free initial consultation. Our clients include individuals, small businesses, entrepreneurs, and anyone serious about saving and investing for their future.
