More and more, Americans are becoming interested in cryptocurrency, and the IRS has taken note. Your 2021 tax return now asks a new question: “At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?”
If you didn’t buy cryptocurrency at all or bought it and held onto it, you would answer no. But if you did sell or trade, the answer is yes, and the IRS will want more details.
History
In 2009, Bitcoin became the first cryptocurrency. It was designed as a peer-to-peer cash system which was easy to use, easy to store, and—most importantly—completely anonymous. As a new form of currency, the world’s governments have had to learn how to integrate cryptocurrency into standing laws, which continue to change as the world of cryptocurrency expands. Today, most cryptocurrency transactions are transparent, and cryptocurrency exchanges have created requirements to prevent money laundering.
In late 2021, President Biden signed the Infrastructure Investment and Jobs Act. The definition of a broker was expanded to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” The act also defines a digital asset as “any digital representation of value which is recorded on a cryptographically secured distribution ledger or any similar technology.”
When transferring securities to another broker, all brokers are required to provide a transfer statement, including a customer’s cost basis and holding period. Under the Act, these transfer statements will be required for digital assets—including cryptocurrency—not only to other brokers but also to non-brokers. This will result in transfer statements being required for transactions such as customers moving tokens from an exchange to an electronic wallet.
With these changes, brokers will need to track and report cryptocurrency and digital asset transactions. Though these new requirements are effective for returns filed and statements required after December 31, 2023, you should begin planning for these changes now.
Keep track of your cryptocurrency transactions
If you’re not already keeping track of your potentially taxable activities, you need to. The IRS requires records any time you sell or exchange virtual currency. You should also be keeping track of your cost basis—what you originally paid for your crypto—as accurately as possible. Even if you are just trading cryptocurrency, keep in mind it’s still a taxable event.
The amount of time you owned your cryptocurrency determines if it’s taxed as a long-term capital gain or a short-term gain, affecting which tax rate is applied. If you held onto cryptocurrency for more than a year, it would generally qualify as a long-term capital gain. But if you bought and sold it within a year, it’s a short-term gain.
The tax rate also varies based on your overall taxable income, with limits to how much you may deduct in capital losses if your crypto loses value. Long-term gains are taxed at a reduced capital gains rate (0%, 15%, or 20% at the federal level depending on your income level), whereas short-term gains are taxed at your ordinary income rate.
When transactions are taxed
Starting in the 2023 tax year, cryptocurrency exchanges will be required to issue a 1099-B, but for now, you’re in charge of tracking your taxable activities. Therefore, it’s important to understand exactly what qualifies as a taxable activity for cryptocurrency.
Since cryptocurrency is treated like investing, the sale of a cryptocurrency or its exchange for another type of cryptocurrency triggers a tax on any profit from that transaction. Even if it is not being exchanged into US dollars, you can still incur a tax bill whenever you’re disposing of assets.
The following are examples of when cryptocurrency is a taxable activity:
- Selling cryptocurrency for fiat money (USD, EUR, JPY, etc.)
- Trading cryptocurrency for another type of cryptocurrency
- Using cryptocurrency to buy a good or service
- Buying, selling, or trading an NFT
The difference between the amount you spent when you bought or received the crypto (its cost basis) and the amount you earn for its sale is the capital gain or capital loss. Any gains or losses must be reported to the IRS.
Additionally, if you received cryptocurrency as payment for a service or in lieu of a paycheck, your crypto will be taxed as compensation in accordance with your income tax bracket. Mining crypto, earning staking rewards, getting an airdrop, and more transactions can be recognized as income.
The following are examples of when cryptocurrency is not a taxable activity:
- Buying crypto with cash and holding it
- Donating crypto to a qualified tax-exempt charity of non-profit
- Receiving a gift of cryptocurrency
- Giving crypto as a gift of up to $16,000 per recipient per year for 2022 ($15,000 for 2021)
- Transferring crypto between accounts or wallets
This list isn’t comprehensive or exhaustive, so keep track of any time you receive “free” cryptocurrency (except as a bonafide gift), as it is likely to be subject to tax.