There’s been a lot of talk about cryptocurrencies or virtual currencies, including how much they’re worth and the transactions in which to buy them. What happens, though, when you sell them or use them to buy something? Do you have to worry about taxes?
Let’s look at some of the different applications of virtual currency.
The IRS has determined virtual currency is property. This means that gain or loss applies if the virtual currency is a capital asset in the hands of an investor.
When it’s sold, there might be long or short capital gains or losses that need to be calculated just as in selling stocks.
When the virtual currency is purchased for cash (flat money), the basis would be the actual purchase price. However, there are other transactions as an investment where the basis is not that easy to calculate.
Exchanging one type of virtual currency for another one is considered a capital transaction. This is a taxable event because one asset is disposed of and another one acquired. No flat cash is used in this transaction and exchange calculations will have to be done for the basis of the new virtual currency.
There is a transaction called a hard fork. It represents a permanent change to the original cryptocurrency which requires the creation of another separate and distinct cryptocurrency.
Airdrops are another unique transaction with virtual currencies. In this transaction, someone who is participating in a blockchain project in a marketing initiative receives an award for participating.
In exchanges, hard fork transactions and airdrops, there is no easy way to determine the new basis and no exact guidance from the IRS. It is best to work with a CPA or another specialist to help you with those calculations.
Let’s look at some other virtual currency transactions.
Virtual currency can be used for payment of goods and services such as:
An employer can pay an employee with virtual currency. The fair market value on the date of distribution to the employee would be added to the W-2 for that employee.
Independent contractors who provide goods or services and are paid by virtual currencies should receive Form 1099-MISC for the fair market value on the date of payment. This requirement is only if the amount paid to the independent contractor is more than $600 in one year.
Virtual currency also can be used for executive incentives. If it’s used as an alternative for a stock option, it would be less restrictive but treated in a similar manner with the fair market value being added to the W-2 and payroll taxes being taken out. When sold by the employee, the transaction would receive capital gain treatment.
Virtual miners must include the gross amount of fair market value on the date of receipt of the cryptocurrency they receive. Their income may be considered nonpassive or passive depending on the role they play. Each has its own tax ramifications.
Virtual currency lending can happen when owners lend virtual currencies to others. Any interest income received on these transactions needs to be reported on the tax returns filed.
Virtual currency should be added to flat currency and any other assets required under both FBAR and FATCA for foreign reporting. This is only required if the taxpayer’s respective reporting thresholds are met.
Because a basis is established as the fair market value on the day of the transaction, it’s very important the research for that value be done on the same day. Virtual currency transactions are not recorded in a brokerage account as stocks and bond are recorded. You cannot go back and research the value on a particular date.
It’s also important you adopt a thorough and consistent method of keeping track of the basis of your cryptocurrencies.
The answer to the question about the taxability of virtual currencies is yes. Anytime you have a transaction with cryptocurrencies, you need to look at the taxability of that transaction and report it on your tax return.
By MARCIA CAMPBELL | Contributing columnist with THE PRESS ENTERPRISE
PUBLISHED: September 13, 2018
Marcia L. Campbell, has worked as a CPA for over 25 years specializing in seniors, trusts, estates, court accountings and probate litigation support. You can reach her at Marcia@MCampbellCPA.com