Investing in Cryptocurrency? Understand the IRS Tax Implications

There are several reasons why cryptocurrency is piquing the interest of more Americans right now.

As of May 8, more than 200 billion dollars in stimulus checks have been sent to roughly 130 million Americans. More than 150 million more checks are expected to still be distributed in the coming weeks.

While some Americans are cashing checks to cover rent or pay for expenses, others are looking for strategic ways to invest the money. With the current volatility in the stock market, some people are taking a new look at unique investment opportunities such as cryptocurrency and its most popular currency, bitcoin. The once “fringe” financial enigma is year-by-year becoming more mainstream.

There are several reasons why cryptocurrency is piquing the interest of more Americans right now.

Why cryptocurrency?

Bitcoin, the most widely-traded cryptocurrency, has a finite supply of 21 million coins. It was planned, from the beginning, to avoid traditional inflation problems that affect most other currencies. This appeals to some investors who feel like bitcoin may rise in greater value over the coming years.

Also, the current global pandemic may change the rate at which businesses adopt digital currencies. COVID-19 has seen an increase in contactless payments, and in some banks, cash is even being held for up to two weeks before being released, in order to lower the risk of passing infection. While bitcoin is nowhere near being used as a primary currency, the trend of what it represents could increase considerably in light of COVID-19.

Cryptocurrency and the IRS

When bitcoin was first introduced in 2009, the cryptocurrency scene was a bit like the Wild West. There were no rules when it came to buying and selling. That meant cryptocurrency could be used online to avoid IRS regulations. However, it didn’t take long for the IRS to resolve this growing blind spot. In 2014, they issued Notice 2014–21, or “IRS Virtual Currency Guidance.”

Essentially, the IRS has made it mandatory to report bitcoin transactions of all kinds, no matter how small in value. Therefore, every American taxpayer is required to keep records of their trading practices in any digital exchange (the trading platforms for cryptocurrency).

How is it taxed?

Whenever you buy, sell, or trade cryptocurrency, you face tax implications, just as if you were buying or trading stock. As of now, the IRS is viewing cryptocurrency as assets — not currency. That’s an important difference because it changes how it’s taxed.

The IRS has stated,

“General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

Transactions using virtual currency must be reported in U.S. dollars. Taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars … at the exchange rate, in a reasonable manner that is consistently applied.”

In the case of property, capital gain applies when you sell it at a higher price than what you purchased it for. (If bitcoins are held for less than one year before the transaction, short-term capital gains are applied. If held for more than one year before the transaction, long-term capital gains are applied.)

Any capital gain represents increased income, which is subject to tax. When you spend bitcoin or other cryptocurrency, you’re essentially selling property and then spending the equivalent selling price.

Here’s an infographic from The Balance that maps this out in a helpful, visual way:

Tax Tips for Cryptocurrency Traders

Here are some tips to make preparing tax information easier when trading cryptocurrency:

  • Keep in mind that with cryptocurrency, normal capital gains strategies apply: one of our Pine & Co. tax accountants can help you strategize what makes sense with your financial goals.
  • Keep clear records of all your transactions, including whey you buy and sell. This information will be recorded on Schedule D and Form 8949 when it’s time to file your annual income taxes.
  • Finally, monitor tax rates. Any gains made through trading are subject to 3.8 percent net investment income tax.

If you’re interested in buying or selling cryptocurrency, or have recently started trading, check out the IRS published FAQs for virtual currency. It answers a host of questions involving cryptocurrency, from: “If I donate virtual currency to a charity, will I have to recognize income, gain, or loss?” to “What records do I need to maintain regarding my transactions in virtual currency?”

And, of course, our Pine & Co. team is here to answer any other questions you may have about your tax responsibilities. Give us a call to discuss how capital gains tax could affect you this year.

Do you have more questions?

Schedule a consultation with Mike and his team today.

Stop being anxious about your financial future. Choose Pine & Co CPAs as your tax strategist so you can keep as much money as possible, grow your wealth, and have more time for the people and hobbies you love.

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