Did you sell or exchange any cryptocurrency during 2020? If so, you must disclose this information when you file your personal taxes this year, and you must pay cryptocurrency taxes. Federal tax Forms 1040 and 1040-SR specifically ask whether you sold, received, sent, exchanged, or otherwise gained any financial interest in a virtual currency at any time during 2020. The form requires you to check “Yes” or “No.”
There’s no avoiding this disclosure or payment of associated taxes—regardless of whether you receive a 1099-K, 1099-B or 1099-MISC from a crypto exchange. Cryptocurrency and its taxes are new to many people. Take the necessary steps to make sure you aren’t paying too little or too much. Start by reviewing how the IRS defines and taxes cryptocurrency.
How the IRS Defines Cryptocurrency
The U.S. government categorizes cryptocurrency as virtual currency that uses cryptography. It doesn’t consider cryptocurrency to be“real” currency, like the U.S. dollar. However, the IRS acknowledges that while many people only invest in cryptocurrency, others use it to purchase goods and services. When used in the latter way, it has an equivalent value in real currency. The IRS calls this “convertible virtual currency.” For tax purposes, the IRS treats cryptocurrency as property.
How the IRS Taxes Convertible Virtual Currency–Cryptocurrency
Selling, trading, exchanging, and mining cryptocurrency are taxable actions. Purchases you make with cryptocurrency are also taxable. Plus, cryptocurrency bonuses, perks, and payments you receive are taxable as income. Hard forks and airdrops are additional taxable events.
The IRS doesn’t require you to pay personal taxes on cryptocurrency holdings or purchases. Tax consequences don’t apply unless you exchange it, meaning if you simply purchased cryptocurrency you can check “No” on Form 1040. You can also gift cryptocurrency and incur no tax liabilities. But the recipients of your gifts will likely need to pay taxes when they sell or exchange them.
Sometimes crypto tokens or coins are swapped. They might also change names or undergo rebranding. If any of this happens, you will only owe taxes if their value changes too.
Cryptocurrency Capital Gains and Losses
To the IRS, your cryptocurrency properties are capital assets. The IRS taxes any profit you make when you sell your Ethereum, Bitcoin, or other cryptocurrency. This includes purchases you make with your virtual currency if the value exceeds the amount you paid initially. Essentially, the IRS says if you’re selling your cryptocurrency at a profit—the goods or services you receive are merely an exchange for the convertible virtual currency.
Both your annual income and the length of time you’ve held your virtual currency affect your capital gains tax rate. If you’ve held your cryptocurrency for less than one year, it is a short-term gain and you will pay taxes at your normal rate. However, if you’ve held it for more than a year and your income meets eligibility requirements, you may pay a lower rate on your long-term capital gain.
Alternatively, your cryptocurrency may have lost value. If that’s the case, you suffer a capital loss when you exchange it for less than you paid for it. This loss may help reduce any personal taxes you owe.
When you mine cryptocurrency or receive it as payments, perks, or bonuses for work you’ve performed or goods you’ve sold, it’s treated as taxable income. The amount is equal to the market rate value on the date you received it. You pay the same tax rate you would on your other income. If you then sell or otherwise transfer that cryptocurrency at a profit, you’ll owe capital gains on that increased value.
Avoid Overpaying or Underpaying Cryptocurrency Taxes
Keep detailed records of all your cryptocurrency transactions. This will make things easier when it comes time to pay your personal taxes. There are excellent software tools that can help you stay on top of these record-keeping tasks. Remember that you are likely to pay a lower tax rate on long-term capital gains, so it may be smart to hold on to your cryptocurrency for at least 12 months. Offsetting gains with losses is another viable option.
If you’ve invested in or otherwise received cryptocurrency, contact Insogna CPA to ensure that you’re not over or underpaying your taxes. We also recommend THIS software to combine your virtual wallets for IRS tax reporting.