“In 2014, the IRS issued Notice 2014-21, 2014-16 I.R.B. 938 (PDF), explaining that virtual currency is treated as property for Federal income tax purposes and providing examples of how longstanding tax principles applicable to transactions involving property apply to virtual currency,” according to the IRS. “The frequently asked questions (“FAQs”) ...expand upon the examples provided in Notice 2014-21 and apply those same longstanding tax principles to additional situations.”
Here are few lightly edited excerpts from the newly published materials:
What is virtual currency?
“Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency. The IRS uses the term “virtual currency” in these FAQs to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.”
How is virtual currency treated for Federal income tax purposes?
“Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency ...For more information on the tax treatment of property transactions, see Publication 544, Sales and Other Dispositions of Assets.”
This year, the IRS wants to know about your cryptocurrency transactions. If you've been mining, buying or selling your bitcoin, here's what you should know. #cryptocurrency
I received virtual currency as a bona fide gift. Do I have income?
“No. If you receive virtual currency as a bona fide gift, you will not recognize income until you sell, exchange, or otherwise dispose of that virtual currency. For more information about gifts, see Publication 559, Survivors, Executors, and Administrators.
"You must report most sales and other capital transactions and calculate capital gain or loss in accordance with IRS forms and instructions, including on Form 8949, Sales and Other Dispositions of Capital Assets, and then summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses.”
What records do I need to maintain regarding my transactions in virtual currency?
“The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns. You should therefore maintain, for example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.”
One of my cryptocurrencies went through a hard fork but I did not receive any new cryptocurrency. Do I have income?
“A hard fork occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income."
A TokenTax blog expands on some of the nuances with respect to hard forks that result in the accumulation of a new cryptocurrency. “The IRS now states that cryptocurrencies received in hard forks result in taxable income in the year that you received the forked coin,” it reads.
The income will be considered equal to “fair market value” of a new currency at the time it is received and recorded, the blog states, so longs as the owner has “dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.” The cost basis becomes the income amount reported upon receipt.
New this year, holdings need to be reported: Forbes
According to Forbes, prior to 2019’s tax year, no action was needed to merely hold virtual currencies. However, those filing this year will notice that isn’t the case anymore. Take a look at the top of the IRS Schedule 1 form, specifically the language regarding “financial interest” in virtual currency. “Holding cryptocurrencies is clearly not a taxable event so you will not owe any taxes for holding. But, now you have to disclose your ownership/affiliation to the IRS by checking ‘yes’ on cryptocurrency question,” notes the Forbes article.
Some holdings would be otherwise unknown by the IRS without this sort of disclosure, according to the article. Among some examples of instances where the IRS would not be privy to disclosures outside of individual reporting are virtual currencies held in decentralized exchanges, hardware/offline wallets or on foreign exchanges.
Disclaimer: this blog entry is informational purposes alone and is not intended to be a substitute for professional tax advice. For such matters, consult a tax professional.