There is a lot of confusion about what needs to be reported on your tax return if you have invested in cryptocurries are based on blockchain technology, like Bitcoin (BTC) or Ethereum (ETH). To report on your taxes, either your brokerage will provide a 1099B with sales and purchase summaries, or you will need to contract with a software company like CryptoTraderTax to convert your transactions to tax return friendly documents.
In this article, we address tax common surprises for those who have purchased or sold cryptocurrency. Of course, exchanging cryptocurrencies involves significant risk – including the possibility that you could lose all of the money you’ve invested. Also, tax treatment of cryptocurrency is also subject to change. For the most up-to-date information, visit the IRS webpage.
Cryptocurrency is essentially looked at by the IRS like a stock.
Transactions involving cryptocurrency — such as purchases of goods or services — become taxable events where the purchase is also considered a sale. Now, imagine if you buy 10 or 15 products per month in a crypto currency account each month. That is 10 or 15 sales per month. This usually causes a very complicated set of facts to convert into stock sales.
Like other investments taxed by the IRS, you’ll face capital gains or losses.
Cryptocurrency owners often are surprised to discover that using cryptocurrency to pay for goods or services can also trigger a capital gain or loss. As with other capital assets, the amount of gain or loss is the difference between the adjusted basis in the cryptocurrency (usually, the amount paid to acquire it) and the amount for which it’s sold.
And, as with other capital assets, gain or loss may be short term or long term, depending on whether an investor held the cryptocurrency for more than one year. If cryptocurrency is sold at a loss, there may be limitations on the deductibility of the capital losses.
Sometimes, you’ll have to report income when you haven’t even purchased or sold.
In some cases, a cryptocurrency owner may recognize taxable income because of certain blockchain events. Taxable income may be triggered even if you don’t conduct transactions or take any other actions with the cryptocurrency.
IRS guidance in 2019 addressed the tax implications “hard forks” and “airdrops,” events can that occur when a single cryptocurrency is split in two. If the new cryptocurrency isn’t airdropped or otherwise transferred to an account of the legacy cryptocurrency’s owner, a hard fork doesn’t trigger taxable income. On the other hand, if a hard fork is followed by an airdrop (which enables owners to immediately dispose of the new cryptocurrency), the owner recognizes ordinary income in the year the new cryptocurrency is received.
This article is for educational purposes only and should not be taken for business advice about your specific situation. Please schedule an appointment with a Principal at Bernstein Financial Services to help you determine your optimal planning strategies.