Cryptocurrency & Tax
by John Schachter, EA
Do you own cryptocurrency like Bitcoin or ether or virtual items like digital coins or tokens?
These items can generate taxable income or, sometimes, deductible losses. And if you hold them in wallets or accounts outside the US, you might need to disclose your holdings on a form called the FBAR. Here is general information about how virtual or digital currency or other items can affect your taxes.
The IRS advises that cryptocurrency is “property.” You generally realize gain or loss when disposing of property. That gain or loss is taxable. The IRS tells taxpayers that gain or loss on cryptocurrency held for investment is capital gain or loss. The tax rate on capital gains is much lower for property held for at least a year. Where you trade in and out of property, it is necessary to do some sort of inventory accounting. By default, the property acquired first is treated as sold first. This is so-called first-in, first-out accounting, or FIFO. But a taxpayer can alternatively use a specific identification method to cherry-pick which units are treated as sold first. This can save tax, so consider whether the specific identification method is possible before you dispose of virtual currency. Please talk to us if you need help with that.
You dispose of a unit of virtual currency by spending it, not just by trading it for other currency. Let’s say you buy a single Bitcoin at $1000 and exchange it for a fancy bicycle worth $2500. You just had a taxable gain of $1500.
If a taxpayer receives virtual currency as payment for goods or services — or if the taxpayer successfully “mines” virtual currency, the taxpayer has income equal to the value of the virtual currency when received. This is not capital income, but ordinary income, taxed at regular tax brackets. If you earn virtual currency as payment for services or in an unincorporated trade or business, the value of the virtual currency received is generally subject to ordinary income tax and also to self-employment tax. And state income tax, too, in many cases.
Most owners of virtual currencies hold their investments in digital “wallets” and trade them on exchanges. Companies in the US and abroad provide wallet and exchange services. There is a lack of definitive guidance on this. But you are likely required to report on the FBAR form your offshore (not domestic) holdings of cryptocurrency if the maximum balance at any point during the year of ALL of your offshore accounts exceeds $10,000. No tax is due with the FBAR. But harsh penalties apply for failing to file the form where required. Indeed, for willful failure to file, the penalty can be 50% of the highest account balance for a year, year after year. Criminal penalties are a further, scary possibility. At John Schachter + Associates, we can help you protect yourself against such troubles by preparing proper disclosures. Be sure to tell us where and how you hold your virtual currency or other digital items of value.
Do you have questions about how virtual currency affects your particular tax situation? Talk to John Schachter + Associates today.
