Virtual Currency: What Does the IRS Think?
First, before we talk about what the IRS thinks about cyrpto, we will start by telling you what this article will not cover. We will not be explaining crypto or virtual currency here. This is a blog about taxes. What we will be discussing is what the IRS thinks it is and how the IRS has determined we will be dealing with the virtual currency transactions. (For the purposes of this article, the terms “crypto” currency and “virtual” currency are used interchangeably.)
Since virtual currency first came into being years ago the IRS has been trying to figure out what to do with it, how to categorize it. One of the attractions of crypto is that it can be decentralized. Hard to track. Virtually invisible. Is it money? Is it property?
Is it Money? Is it Property?
With few exceptions, the IRS has decided we must treat virtual currency as property. The closest comparison in Tax World would be shares of stock. We can deal with this. Many people own virtual currency for the investment value, buying, selling, and trading it on an exchange just like their stock investments.
As an investment property, similar rules apply to crypto as to stocks. It is important to keep track of the purchase info: date, time (in the case of crypto whose value changes by the second), cost, and basis.
The truth is that the tax treatment is not quite that simple.
Tax Treatments
Here are some particulars about certain types of transactions:
Airdrops are considered receipt of new property. As a result, it is subject to income tax on ordinary income on the fair market value (FMV) of the property at the time it is available to dispose. Sometimes you can receive airdropped crypto in your account, and you cannot do anything with it until a later date. At the time it becomes available to you, it is subject to tax. When the income is included in ordinary income and taxed, you now have basis.
Hard forks are also considered ordinary income and are subject to tax at the time the crypto is available.
Staking and mining are considered self-employment, and as soon as the crypto is available to you, it is subject to ordinary income tax as well as self-employment tax.
Trading one type of crypto for another (for example, trading Bitcoin for Ethereum) is considered a sale of the first and a subsequent purchase of the second.
Buying products or services with crypto is considered a sale of the crypto and purchase of your product for the FMV of the crypto at the time of trade. The FMV of the crypto becomes your basis in the product, equipment, vehicle…
Selling an item for crypto currency, as you might expect, is the receipt of payment and is subject to ordinary income tax.
Donating crypto to an IRS recognized charity is considered the contribution of property and subject to the same rules as if you donated clothing to Goodwill or a car to the American Red Cross. The donation amount depends on how long you have had the crypto (your holding period).
ICO’s and IEO’s are treated according to what type of currency was used to purchase the new “coins.” If you use US dollars to buy the crypto, there is no taxable event. If you use crypto to buy the new crypto, you have a sale of property and a purchase of property.
Is it Really That Secret?
Some want to treat virtual currency as foreign currency but the IRS has said unequivocally that it is not. Turning US dollars into crypto in not the same as just exchanging dollars for yen or dollars for pesos. Changing dollars into crypto is considered a purchase and changing crypto into dollars is considered a sale of property.
A heads up to those who have crypto on a foreign exchange: the Financial Crimes Enforcement Network (FinCEN), a division of the US Treasury, has its eyes on crypto transactions on foreign exchanges and held in foreign accounts. Soon we may be expected to file an FBAR (Report of Foreign Bank and Financial Accounts) and Form 8938, following the same rules as those who have cash in foreign banks.
This identification of crypto as property was probably the harshest possible interpretation by the IRS. It was also a huge blow to true believers in crypto as a way to live undetected. In fact, in an attempt to curtail tax evasion, the IRS issued a “John Doe Summons” to Coinbase and other crypto exchanges, requiring them to turn over info on certain investors. Then in 2017, the Tax Cuts and Jobs Act which overhauled tax regulations, did away with “like-kind exchanges” (except for certain real estate transactions), so those who exchange one form of crypto for another form are looking at a sale of assets and subsequent purchase.
What about Our Tax Returns?
How are we ever going to keep track of all this? The FMV of crypto changes by the minute. Transactions are executed all day long. All the previously mentioned transactions effect your basis. The answer: keep good records. There are many coin tracking software apps available to track these rapidly occurring transactions. Some are free depending on the number of transactions you have. My clients who own crypto can expect to answer a list of questions and to provide reports from coin tracking software so that we can have the most accurate picture of their tax situation at tax time.
If you have any questions about the tax treatment of your crypto transactions or information about tracking software, please call First City Income Tax at 912-335-5404. If you know someone who has questions, please feel free to share this article.