The use of Cryptocurrency, or virtual currency, has been steadily on the rise in the past few years due to its ease of international use and investment potential. So, that means that it’s become an area of concern for individual and business taxpayers as well. With this new type of currency comes new questions, and the tax-related laws and best practices regarding cryptocurrency aren’t always clear to virtual currency newcomers.
Perhaps you have purchased virtual currency as a capital asset, or maybe you have been paid in Bitcoin at your full-time or freelance position. More and more retailers are starting to accept virtual currency as a form of payment. So, if you have conducted different transactions with Bitcoin or other cryptocurrencies, it is good to be informed of what you need to file for your taxes.
Regardless of the exact scenario(s), the Internal Revenue Service (IRS) has recently clarified the tax treatment of virtual currency transactions, and there’s a lot to consider when it comes to cryptocurrency and your annual tax returns.
So, if you have started using cryptocurrency in any form, or plan to do so in the future, here are the nuts and bolts of what to know when it comes to filing your 2021 taxes.
Simply buying cryptocurrency, like Bitcoin, and either keeping it in one spot or transferring to a virtual wallet won’t affect your taxes. If your only crypto-related transactions were purchasing some sort of virtual currency with American dollars, then no reporting to the IRS is required on your 1040 tax return.
Your taxes start to factor in when you start to use cryptocurrency as a method of exchange, such as trading one type of cryptocurrency for another, or exchanging your Bitcoin or other e-currency for U.S. dollars. Essentially, the IRS considers virtual currencies that are held as capital assets property, and because general tax principles that apply to property transactions also apply to transactions using virtual currency, their taxable value is based on capital gains or losses.
The difference between what you spent when you purchased or received your cryptocurrency, and what you earned when you sold it, is the amount you’ll use as the capital gain or capital loss. Simply put, you’ll want to treat cryptocurrency as you would any stock, bond, or investment property, and the IRS’ Publication 544 on Sales and Other Dispositions of Assets is a good starting point for additional information on how to report capital assets, capital gains, and capital losses.
Keep in mind that if you have been paid by an employer or contractor in Bitcoin, you will also have to report these as earnings to the IRS on your W-2 form. To do so, you’ll need to do a conversion of the Bitcoin value to U.S. dollars on the date that each payment is made, (as opposed to all at once), and will need to keep track of when these transactions occurred.
Where to find more information
Cryptocurrency and its uses are fairly new to the economic landscape, and the IRS has several resources to help everyday taxpayers determine how to proceed with their annual taxes.
In 2014, the IRS issued IRS Notice 2014-21, also known IRB 2014-16, as a general guide for individuals and businesses on the tax treatment of transactions using virtual currencies, and this lengthy bulletin has a wealth of information aimed at clarifying cryptocurrency when it comes to your federal taxes.
An easier-to-digest resource is the IRS’ Frequently Asked Questions on Virtual Currency Transaction, which covers the basics on virtual currency, and how it should be reported when tax season arrives.
Waters Hardy & Co Tax Professionals
So, remember that if you still have questions after perusing the basics, or simply don’t have the time or bandwidth to wade through ample IRS documentation, the tax professionals at Waters Hardy & Co, P.C. are here to help. We’re always monitoring the latest changes and adaptations when it comes to all aspects of tax laws and services, and this certainly includes the use of cryptocurrency.
Contact us today to review your specific questions on cryptocurrency – from investments to everyday use – and we’ll provide you with all of the information you need to have the most accurate and beneficial tax return possible, for both the coming year and for many years to come.