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Cryptocurrencies have taken the world by storm. These digital assets with decentralized structures had values that kept on leaping high, attracting several investors around the world. As a result, investors have had their fair share of profits from trading virtual currencies.
But how about taxes associated with cryptocurrency? Turns out that if you’re a crypto investor, you need to pay due taxes as well. Cryptocurrency tax rules were first enforced by the IRS in 2014. These policies were further strengthened by the end of 2019.
If you’re unsure about the facts regarding taxes in cryptocurrency activities, we have created this quick simple guide for you:
The Internal Revenue Service (IRS) classified cryptocurrencies like Bitcoin as property in 2014. This means that virtual currencies will be treated the same as real estate is, even if it functions more like securities and real-world currencies.
Cryptos are now considered as capital assets. This means that cryptos join the ranks of land, buildings, structures, and intellectual properties. As capital assets, cryptocurrencies yield capital gains and losses as a result of its use and trade.
Now, since virtual currencies are treated as property, the IRS mandated that cryptos will follow tax reporting policies similar to real estate.
Several crypto proponents, investors, and traders were surprised by the IRS’s decision to tax virtual currencies. Nevertheless, cryptos are meant to be taxed in the long run. It functions like normal money, after all. Also, taxes will always be imminent, regardless of its class and nature.
A brief story about the IRS and Crypto
Concepts and rules regarding virtual currencies have evolved since the IRS decided to tax these assets in 2014. By the end of 2019, the IRS started issuing more stringent policies regarding cryptocurrency taxes. These policies are expected to become even stricter during the current year 2020.
Here are some of the pertinent tax rules to keep in mind when preparing your crypto tax filing:
If you held a cryptocurrency for less than a year, then your profits will be taxed as a short-term gain or as ordinary income. Meanwhile, virtual currencies held for more than a year will be taxed as long-term capital gains. Consequently, losses from cryptos owned for more than are year will be filed as deductible capital losses.
This rule has been enforced since the inception of cryptocurrency taxing in 2014. It remains the standard policy for reporting and computing your cryptocurrency taxes until today.
Taxable transactions that involve bitcoins or any other virtual currency must be included in your tax report. These transactions include the following:
- Purchasing cryptocurrencies for trading and investing activities
- Using crypto coins to buy something, be it a physical item or a digital one
- Trading a certain cryptocurrency for another crypto coin
- Selling your cryptocurrency for cash
Investors who engage in a buy-and-hold (HODL) strategy do not owe taxes regarding their activity. This is because these investors do not touch their coins for a long period, regardless of market fluctuations in the coins’ value.
Merely transferring coins do not also constitute a taxable transaction. You don’t owe the IRS taxes if you simply transfer coins from an exchange to a wallet and vice versa.
Hard forks happen when blockchain changes create a forced split. The result is a new chain created out of the old one. The old blockchain continues to operate alongside the new chain.
You can visually interpret hard forks as a real fork where the long fork base represents the old blockchain and the prongs represent the new chains.
Now, the IRS has been mum regarding their position on blockchains in 2014. But the agency already released guidelines regarding hard forks on its Revenue Ruling 2019–24.
Hard forks will not be taxed if they do not include airdropped tokens or coins. By definition, airdrops pertain to new tokens or coins given to another chain’s addresses. Going back, such kinds of hard fork transactions are not taxable because no gross income is derived from them.
Meanwhile, hard forks with airdrops are considered as taxable events. This is because gross income can be taken from the transaction with the creation of a tradable good with value (the airdrops). The basis for the tax amount will be the airdrop’s fair market value at the time of acquisition.
As previously defined, airdrops are new coins given to addresses of another chain. Airdrop distribution can be viewed as a random marketing activity for crypto participants.
Now, airdrops are considered as ordinary income. Hence, this income should be reported right away after you get the airdrop. If at any time you dispose of the coins in the future, your cost basis will be the value of your reported income.
Cryptomining is the process of verifying and adding new transactions to the respective digital currency’s blockchain ledger. It is also commonly known as mining. Making money is the ultimate goal of most crypto miners.
Participating in mining pools where cryptocurrency miners share their processing power and resources can be reported as ordinary income. So basically, you’ll shell out money to mine coins and get rewarded with coins worth more than the money you’ve spent. Profits derived from this activity creates ordinary income and will be taxed accordingly.
Donating cryptocurrency to charities is classified as a tax-deductible activity.
For instance, you bought a bitcoin for $3,000, held it for more than one year, and donated it to a charity when the value soared to $5,000. Declaring this activity will give you a $5,000 tax deduction. Furthermore, a tax won’t be levied to your $2,000 gained over a year.
But do note that since cryptos are properties, gifts of properties that are higher than $5,000 require an appraisal. Also, holding a coin for less than one year and donating this appreciated property will give you a tax deduction that is only limited to your cost basis.
The Foreign Bank & Financial Accounts form (FBAR) and Foreign Account Tax Compliance Act (FATCA) are two agencies that oversee offshore financial accounts. They both urge the public to disclose information about securities and cash held in offshore accounts.
Since cryptos are maintained as property, you aren’t mandated to disclose account information about them to FBAR and FATCA. Hence, it’s fine if you don’t reveal information about offshore-based crypto accounts, such as those from Binance (a Malta-based crypto exchange).
However, this exemption doesn’t mean that you should not report sales and gains taken from any of your cryptocurrency accounts, be it offshore or US-based. Most tax experts and lawyers still recommend to file reports, especially if you may potentially cross the agencies’ respective thresholds:
Filing is a better option than face more costly penalties in the long run.
What should you do if you bought two sets of crypto coins at different prices, then decided to sell one coin at a time? Indeed, the differences in prices have an impact on your reported income and will also affect your taxes.
For instance, you bought 3 bitcoins for $3,000. After that, you bought 3 more bitcoins for $6,000 at a later time. Then, you decided to sell one coin for $8,000. How would you identify which crypto coins sets gave you a bigger lot or gain? Note that this spells the difference between a gain of $5,000 and $2,000, respectively.
IRS came up with two possible solutions:
This policy dictates that you’ll regard the sold coin as coming from the first set. You may get higher tax bills when you use First in, First out, considering the rapid fluctuations in cryptocurrency values.
First In, First Out
This policy works well if you’ve kept a specific record of each of the coins you bought and sold. Using specific identification can help you minimize your tax bills. Consider using an accounting service to help you keep tabs on your coins for easier identification.
Transactions through your crypto ecosystem
If you gave bitcoins or other cryptos to your family and friends, they can use a cost basis and holding period similar as if you’re still the coins holder.
A unique policy is enforced if the value of the coins fell while they are still under your ownership. This is better illustrated in an example:
You bought a bitcoin worth $15,000. However, the value has fallen to $13,000 while you still hold the coin. You decided to give the coin to your brother, who received it at $13,000 value.
Your brother can then sell the bitcoin for more than the original value of $15,000. If he does, his cost basis becomes $15,000. But if your brother decides to sell the coin for $13,000 or less, then the cost basis falls to $13,000. Any capital loss he’ll claim in the future will be reduced if he follows the $13,000 cost basis.
Staking in cryptocurrency means supporting blockchain operations and certifying transactions by holding certain funds in a crypto wallet. These funds come from participants who put up their coins as collaterals.
Participating in cryptocurrency staking may earn you reward coins, which can be viewed similarly as bank account interests. Hence, staking translates to ordinary taxable income.
Some coin exchanges handle staking operations then split their revenue between them and the participant. In that case, the participant must declare his share of the split revenue as his income, not the entire gross amount.
Cryptocurrency tax rules were enforced by the IRS since 2014. The agency has since then released more streamlined guidelines by the end of 2019 and is expected to intensify the hunt against crypto users who do not pay their due taxes. Make sure you’re with a platform that keeps your information safe.
Cryptocurrencies of any kind are now considered as property. Hence, tax rules applicable to real estate are used for virtual currencies as well.
We’ve presented you with 10 cryptocurrency tax rules in this article. We hope this information guides you in determining and preparing taxes related to your virtual currency transactions. If you’re interested to learn more about us, visit our Wiki page or talk to us directly through the webchat.