Cryptocurrency has become an increasingly popular asset in the last several years, especially as the value of Bitcoin and other cryptocurrencies skyrocketed. In recent years, cryptocurrency is a hot topic and regularly discussed, as more people invest. Accordingly, it’s important for taxpayers to understand how their cryptocurrency investments are taxed. Here are five things taxpayers should know about cryptocurrency and taxes.
1. Cryptocurrency Is Considered Property for Tax Purposes.
The IRS considers cryptocurrency to be property for tax purposes, not currency. This generally means that the same rules that apply to other types of property, such as stocks or bonds, also apply to cryptocurrencies. As such, any gains or losses from the sale or exchange of cryptocurrencies must be reported on your tax return as capital gains or losses.
2. You May Have to Pay Taxes on Gains from Cryptocurrency Transactions.
Any gains from the sale or exchange of cryptocurrency must be reported on your tax return as capital gains and will be subject to taxation at both the federal and state levels. The amount of tax you owe will depend on various factors, including the type of transaction and the length of time between purchase and sale. It’s important to keep accurate records of all transactions involving cryptocurrency so that you can report them accurately on your tax returns.
3. Cryptocurrency Payments and Mining Are Subject to Taxation.
If you run a business and a customer pays you with cryptocurrency, the payment for services is considered taxable income. Similarly, if you are a miner who earns income from mining activities, that income is considered taxable income and needs to be reported on your tax return as well. Furthermore, if your service business or mining activities constitute a self-employed business venture, then any resulting profits will be subject to self-employment taxes in addition to ordinary income taxes.
4. You May Have Foreign Reporting Requirements.
Taxpayers must file a Foreign Bank Account Report (FBAR), FinCEN Form 114a, when he or she have a financial interest in or signature authority over any foreign financial accounts with a combined value of $10,000 or more at any time during the calendar year. According to Notice 2020-2, the Financial Crime Enforcement Network (FinCEN) intends to propose including cryptocurrency held in foreign accounts that exceed the threshold requirements on FBARs. Additionally, taxpayers should also generally be aware of Form 8938, Statement of Specified Foreign Financial Assets. Taxpayers should talk to their tax professional related to their reporting requirements of cryptocurrency held in foreign bank accounts.
5. Gifting Cryptocurrency May Generate Charitable Contribution Deductions.
Taxpayers have the option to gift their cryptocurrency holdings to charity, assuming the charity will accept the contribution. Any gifts of virtual currency to a qualified charity will be recognized as non-cash contributions by the IRS. The value of the donation will depend on the taxpayer’s holding period, the fair market value of the cryptocurrency, as well as the value on the cryptocurrency’s receipt date. Taxpayers should be aware that: (1) any charitable contribution deductions will generally only be recognized by taxpayers who itemize their deductions, and (2) any charitable contribution of cryptocurrency with a value of more than $5,000 requires a qualified appraisal.
Conclusion
Cryptocurrency can provide an exciting opportunity for investors looking for alternative investments beyond traditional stocks and bonds – but before investing it's important for taxpayers to understand how their cryptocurrency holdings will affect their taxes and reporting obligations each year. Taxpayers should keep these five things in mind when investing in cryptocurrency. Understanding how cryptocurrency works within the framework of existing tax law is essential for anyone interested in investing in Bitcoin, Ethereum, etc.
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