the boss who pays employees in cryptos,
the employee who receives payment in cryptos,
those who received air-dropped tokens, forked coins or tokens,
those who exchanged coins for different ones,
the staker or lender, and
Cryptocurrency tax implications.
You could owe the taxman money if you:
- Actively buy and sell crypto
- Pay someone wages in crypto
- Receive wages (W-2) or income (1099) for work performed
- Purchase goods or services with crypto
- Mine crypto
- Receive air-dropped crypto
- Receive crypto because of a chain split (i.e., fork)
- Exchange one cryptocurrency for another
- Stake or lend crypto
The Internal Revenue Service (IRS) issued Notice 2014-21, which gives taxpayers some guidance on the tax treatment of transacting in cryptocurrencies, or as the IRS refers to them, “virtual currencies.” More recently, the IRS issued Revenue Ruling 2019-24 and updated Q&A format guidance, which gives taxpayers further tax guidance on cryptocurrencies, specifically around hard forks and airdrops (you may have taxable income to report on that bitcoin cash fork back in August 2017!).
Basically, the IRS treats virtual currencies as property – which means it will typically be taxed as a capital asset like a stock or bond – rather than a currency. This allows the IRS to tax any profit realized on the sale of cryptocurrency, and means that any goods or services purchased with cryptocurrency are treated as a “sale.”
For example, if you bought bitcoin (BTC) with U.S. dollars (USD) on January 1st, exchanged it for ether (ETH) on June 30th, and then purchased groceries with the ETH on July 1st of the following year, you would have two separate taxable events, one on June 30th and one on July 1st of the following year, but the tax rate applied when you exchanged BTC for ETH will likely be different (i.e., higher) than the tax rate when you used the ETH to purchase groceries. This is because property held for one year or less is subject to short term capital gains treatment when sold or exchanged, which in most cases will be a higher rate than long term capital gains rate, which is applied to sold or exchanged property that was held for more than one year.
However, you only owe taxes if you realize a gain. If upon the sale, exchange, or use of your cryptocurrency, you have a loss, you don’t owe any taxes on that transaction, and you could apply those losses to offset other investment gains that you may have realized during the year.
If you receive cryptocurrency – through mining, staking, or lending, a promotion (i.e., an air drop), or as a payment for goods or services – it should be reported as ordinary income, which is taxed at your highest marginal rate. Plus, if, when you go to sell/exchange/spend your cryptocurrency, it has increased in value, that transaction becomes another taxable event.
Wash Sale Rules
Wash Sale Rules do not currently apply to cryptocurrency, but, depending on the passage of pending legislation, it might soon.
You may already be familiar with the Wash Sale Rule as it applies to stock sales and purchases. It states that any loss associated with a sale of shares can not be claimed if the seller purchases additional shares of that, or substantially identical security, within 30 days of the sale. The loss does not disappear but is deferred until you sell the newly purchased stocks.
Of course, if you purchase crypto-related securities, the Wash Sale Rule would apply to them.
Additional Taxable Situations and Penalties for CryptocurrencyThere are other tax traps that crypto enthusiasts may not be not aware of, such as:
- Offshore exchanges and digital wallets that are operated by foreign third-party providers may be subject to FBAR and FATCA reporting requirements (failure to report could mean stiff civil penalties and potentially criminal penalties of up to 5 or even 10 years in prison!).
- As alluded to previously in this article, as of January 1, 2018, taking a section 1031 like-kind exchange election with respect to cryptos will probably not pass muster with the IRS (i.e., when you convert your bitcoin into ether, you may now have a taxable event).
- Other than a couple of narrow exceptions, losses (e.g., theft via a hacked wallet) are no longer deductible for tax purposes.
- Before you buy that Cybertruck with DOGE, you might want to think twice. Using crypto to make such a purchase might require that your crypto be treated as personal use property for tax purposes, which could mean higher taxes for you.
- Non-fungible tokens (NFTs) are taxed at a different rate than most cryptocurrencies because they are likely to be deemed collectibles for tax purposes.
What does all this mean to you?
It means that it’s extremely important that you track the quantity, price (in USD), and date of when you buy, sell, receive, spend or exchange cryptos (in tax parlance, this is called basis tracking). There are online basis calculators that can help you keep track of your transactions.
It's also important that you follow any changes to the tax laws as they could definitely impact your crypto investment strategy, especially if you are a frequent trader.
Holding cryptos can make your tax situation more complex, and this article doesn’t even cover other important aspects of investing in cryptocurrencies that you might not be aware of! We strongly recommend that you seek the advice of a tax professional if you hold or have ever transacted in cryptocurrencies.
Need tax help with your cryptoassets? Please contact us here to set up a consultation. Want to learn more about cryptocurrencies and advanced tax strategies? Check out this article published by the The Tax Adviser, an American Institute of Certified Public Accountants (AICPA) publication. Mercer Street offers financial planning and investment advisory services to international professionals and small business owners, as well as business consulting and tax consulting services. We specialize in advising on cryptocurrencies. Check us out at www.mercerst.io.
Editor's Note: This article was originally published on September 20th, 2018, and has been updated for accuracy and comprehensiveness. The most recent update was on January 18th, 2022.