Have you dabbled in cryptocurrency this year? If so, understanding what the IRS deems a taxable crypto event is essential.
Whether you’re an experienced currency trader or are just starting crypto mining, exchanging, spending, or receiving, you must comply with the tax implications. The reporting method you should utilize depends on how you received or used cryptocurrency over the past financial year.
In the rest of this article, we will talk you through the importance of declaring cryptocurrency on your tax return, how the IRS handles crypto transactions, and the specific usage-specific guidelines.
Cryptocurrency Tax Guide: The Importance of Declaring
Everybody seems to be using cryptocurrency these days — and the IRS is well aware of this! However, they estimated that just a portion of people trading crypto were actually reporting such transactions on their returns.
To combat this problem, they announced a cryptocurrency tax enforcement initiative in October 2019. Ever since, the Internal Revenue Service has been trying to ensure everybody conforms to these rules.
How The IRS Taxes Cryptocurrency
Here is where it gets a tad confusing. Although we consider cryptocurrency to be a virtual currency, the IRS doesn’t agree. Per the IRS Notice 2014-21, the Service states, “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply.” In other words, you need to report capital gains and losses on Schedule D (Form 1040) and potentially Form 8949.
Your cryptocurrency gains may be short- or long-term, depending on how long you held before exchanging or selling. Follow the two rules below to determine which term your yields fall under:
- Short-term capital gains — You held the virtual currency for one year or less, so you’ll pay your standard income tax rate.
- Long-term capital gains — You held the virtual currency for over one year, so you’ll pay long-term capital gains tax rates.
How to Declare Cryptocurrency Transactions on Your Tax Return
To decide the method, you should use to report cryptocurrency on your tax return, you need to accurately establish how you acquired and used it. We will walk you through the specifics for each of the four unique uses below.
Tax Reporting Specifics for Crypto Miners
As a crypto miner, you use hash functions to validate and input currency transactions to a blockchain. You’re paid in cryptocurrency for the work, which the IRS must know about.
When earning through mining, it’s classed as taxable income. In this case, it may be stated on Form 1099-NEC on the day you acquired it, like standard types of self-employment income. Having said that, it’s important to report it even if you don’t get a 1099 form!
Tax Reporting Specifics for Cryptocurrency Payments Receivers
If you run a business that accepts virtual currencies like Bitcoin for your products and/or services, the IRS treats these payments like standard taxable income. When reporting it, ensure the dollar value you get for your wares is the same as the fair market value of the crypto when you acquired it.
Tax Reporting Specifics for Crypto Sellers or Spenders
Compared to sellers and spenders, payment receivers and miners have it easy! As somebody who buys, mines, or receives crypto and eventually sells or spends it, you have a capital transaction to deal with (similar to if you sold stock shares). Instead of treating it like regular taxable income, you must contend with capital gains taxes.
But don’t fear; I’m here to guide you through it. Let us look at an example to make life easier.
Scenario: You get $500 worth of Bitcoin in exchange for your service on January 23. Flash forward to July 23, the Bitcoin fair market value has increased your stash to $1,000. You decide to use it to pay for an all-inclusive vacation.
Tax return: When doing your tax return, you must add $500 of regular income for the Bitcoin you received in January and a short-term capital gain of $500 (i.e., $1,000 minus the $500 basis).
Simple enough, right? If you track your crypto uses, you won’t have a whole stack of transactions to unravel every time you complete your tax return.
Tax Reporting Specifics for Cryptocurrency Exchangers
Even if you aren’t spending your crypto on physical goods or services, you need to report your exchanging (i.e., trading one type of cryptocurrency for another) habits to the IRS under capital gains.
The Bottom Line
Hopefully, this cryptocurrency tax guide has made the otherwise daunting task of filing your return a little less intimidating. Keeping it handy while completing the forms will help you stay on track and include all the relevant information.