Keep in mind that where the Internal Revenue Service (IRS) is concerned, cryptocurrency is considered as personal property for taxation purposes. The acts of selling, exchanging, and spending cryptocurrency, which include virtual currencies like bitcoin and altcoin, will likely have implications in capital gains and losses. Even the receipt of bitcoin as a form of compensation is considered as ordinary income and, thus, taxable.
The bottom line: You should declare your cryptocurrency transactions on your tax return, when applicable! Your tax preparer at H&R Block should be able to deal with it in the appropriate manner but it also pays to know the basics, as discussed below.
The Tax Implications of Cryptocurrency Use
While the IRS has yet to issue definitive guidelines about the exchange, receipt and sales of cryptocurrency, the following general guidelines apply.
- The capital gains and losses from trading cryptocurrency can be treated in a similar manner as ordinary income. For example, capital losses can be used to offset capital gains and, thus, to reduce tax.
- The capital gains and losses are also recognized on cryptocurrency exchanges, such as buying bitcoin by using Ethereum. The taxable event arises from the fact that the token is considered as sold during the exchange.
- The fair market value of the cryptocurrency at the time of its receipt is used for taxation purposes. This applies to the receipt of cryptocurrency for compensation or for the purchase of products and services.
- The rates that apply to short-term and long-term capital gains and losses also apply to spending cryptocurrency.
- The conversion of cryptocurrency to U.S. dollars or any other recognized currency resulting in a gain is also considered as taxable. Capital gains should be declared.
These general guidelines also apply to air drops, mining coins, and initial coin offerings.
Other Things to Remember
The IRS has yet to provide clear instructions on exchanges of cryptocurrency but you, the taxpayer, can pick your methodology in setting up your account. Just be sure to use the same methodology on your return – consistency is the key here. The IRS, however, will likely use the First-in, First-Out (FIFO) method.
The IRS has a more lenient attitude toward taxpayers who come forward with their cryptocurrency use than for those who waited for discovery. For this reason, you should adopt a self-reporting approach, especially since cryptocurrency exchanges neither issue a 1099 form nor make calculations for cost basis and capital gains for traders.
Indeed, cryptocurrency may be the newest way to build up your wealth. But always remember that, sooner or later, the taxman will come after it so it pays to be aware of its tax implications.
