Ever since Bitcoin's emergence over a decade ago, much confusion still surrounds its tax implications. While Bitcoin was initially designed to be a currency for daily transactions, it has so far struggled to gain that traction. On the bright side, it has attracted speculators and traders hoping to profit from its volatility.
In 2014, the Internal Revenue Service (IRS) addressed the matter of cryptocurrency transactions in its notice 2014-21, declaring cryptocurrencies as an asset akin to property. The IRS began asking about cryptocurrency transactions in its Form 1040 as of 2020.
Tax rules often vary based on the kind of transaction and the asset involved. However, Bitcoin's unique characteristics and uses cause many exceptions and constant changes in tax laws.
Bitcoin, now listed on exchanges and paired with leading world currencies like the U.S. dollar and euro, is viewed by the IRS as a separate digital representation of value. Whether it's Bitcoin, Ethereum, or smaller altcoins, these virtual currencies are treated as property, and general tax principles frequently apply to these assets.
The type of gain or loss (short-term or long-term) depends on how long the virtual currency was held. Capital gains or losses must be recognized when selling virtual currency, subject to certain limits on the tax deductibility of the taxpayer's capital losses. These rules are established by IRS Publication 544.
Bitcoin and other digital assets, in a broad sense, are taxed similarly to other capital assets like stocks, bonds, precious metals, or certain personal property. Their tax rates depend on the taxpayer's tax status and income.
The IRS has offered guidance on transactions involving digital assets and advises seeking tax advisor guidance due to the difficulty in tracking all transactions.
The cost basis of Bitcoin, utilized to determine the gain or loss, is the cost at which the digital currency was obtained. However, less straightforward transactions complicate matters. For instance, no-cost investors might receive airdropped tokens or tokens in return for a service. Much like stocks and bonds, Bitcoin would typically have a basis equal to the fair market value at the time of acquisition in these situations.
Cryptocurrency mining is a taxable event with deductions available for equipment and resources used. Deductions differ based on the reason for mining: personal or business benefit.
Converting one cryptocurrency to another was once argued to be a like-kind transfer under Section 1031 of the Internal Revenue Code, deferring income tax. However, in 2021, the IRS declared such exchanges don't qualify as like-kind exchanges.
Digital currency received in a transaction performed via exchange is recorded at the time of the transaction by the exchange. If received through a transaction performed off-chain, its base value becomes the fair market value of the exchange.
Cryptocurrency hard forks or blockchain splits, which produce a new coin, may come with new coins for holders of the original cryptocurrency. A 2019 IRS ruling clarified that hard forks that don't yield new cryptocurrency units don't result in gross income. Yet, airdrops (after hard forks or by coin marketers) count as gross income.
Cryptocurrency donations are tax-deductible, with limits based on the donor's AGI. Moreover, the IRS allows an annual gift tax exclusion-$16,000 in 2022, and $17,000 in 2023.
Not selling your digital currencies during the tax year is one way to avoid paying taxes. Most taxable events occur from selling or exchanging cryptocurrencies. Centralized exchanges often require client information, including photo identification. If a trading platform gives you a Form 1099-B or Form 1099-K, the IRS becomes aware of your transactions.
Deliberately not reporting taxes on any source of income, including cryptocurrency, is tax fraud. Consequently, the IRS could audit you.
Cryptocurrency is an evolving and volatile market. Understanding the tax implications of your digital currency transactions is crucial-it's either the acquisition cost or the fair market value at acquisition. Deliberate evasion of taxes on cryptocurrency transactions is tax fraud.