The first Bitcoin was released and traded in 2009. Since then, the wild proliferation of new cryptocurrencies has only continued to outdo itself. Just because this type of financing is still in its infancy, it doesn’t mean crypto is our new Wild West.
The IRS issued its first tax guidelines for cryptocurrencies in 2014, declaring that since Bitcoin and its cousins must be sold to register transactions, they’re categorized as property — which can appreciate and depreciate accordingly. And recently, President Joe Biden issued an executive order to start organizing regulations for cryptocurrencies. Skeptics feared it would signal a crackdown on crypto marketplaces and a damper on financial innovation, but the text of the executive order is much more focused on consumer protections and illicit activities.
Still, both accountants and crypto investors ought to focus on learning what they don’t yet know. In a prior article, we have laid out an introduction to the tax implications and basic workings of cryptocurrency. “Purchasing goods and services with cryptocurrency could result in capital gains,” it states. “Imagine having a reporting requirement every time you purchased groceries because appreciated property was used as payment.”
If you’re new to virtual currencies, crypto-curious or already an expert, here are five things you should know about how this new type of financing can affect your taxes.
1. Buying crypto is like buying an asset. The IRS defines crypto as “property”, as opposed to a currency or a security. You’re off the hook on taxes if you only bought cryptocurrency and didn’t spend any. Likewise, if you receive crypto as a gift but don’t spend it, that’s not a taxable event. Per the IRS, in that scenario, “you are not required to answer ‘yes’ to the Form 1040 question, and should instead check the ‘no’ box.” On the flip side, as touched on above, spending crypto is the equivalent of trading property for goods or services and results in a taxable transaction.
2. Keep track of your cost basis. Knowing how much the currency is worth when you acquired it (either through purchase, transferred for another cryptocurrency, or otherwise received) will determine any gains or losses. Any good cryptocurrency wallet should maintain these values on the blockchain.
3. Crypto received for services is taxed like regular income. The amount of income is equal to the market value of the crypto the moment it is received. That also means relevant deductions will apply if an employer or customer pays with virtual currency.
4. A charitable donation of crypto doesn’t count as a sale. In this situation, you “recognize no income, gain, or loss from the donation.” If you’ve had that particular currency for more than a year, a contribution to a valid charity is equal to the fair market value of the currency at the time you gave it. However, if you’ve had it for less than a year, “your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution.”
5. The IRS wants legible records of your crypto activity. You should be able to prove any of the above in an audit. The IRS thus recommends keeping “records documenting receipts, sales, exchanges or other dispositions of virtual currency and the fair market value of the virtual currency.” Talk to your accountant or tax professional for recommendations on staying consistent and well-organized while managing your virtual currencies.