In October 2019, the IRS issued some of the most significant cryptocurrency guidance yet and the first update in 5 years. Crypto users and expats alike eagerly anticipated his IRS guidance for the tax treatment of virtual currencies.
The new 2019 IRS guidance answers many key crypto tax questions, including:
- Report crypto received as income
- Report crypto received via airdrop
- Calculate the cost basis of cryptocurrency
- Calculate capital gains when selling cryptocurrencies (accepted accounting methods)
- Small Transactions
1. Taxes for cryptocurrency received as income
According to the new IRS crypto guidance, if you are paid in cryptocurrency for services rendered, then the payment is subject to US income tax. Importantly, cryptocurrency received through mining is also considered income.
If you received cryptocurrency as income you must calculate and report in US dollars the cost basis of the crypto at the time you received it.
This also brings up the important issue of how taxpayers should report new cryptocurrency received as a result of a hard fork.
2. Reporting cryptocurrency received via airdrop
Airdrops are often an exciting event for crypto holders. However, they are not without tax implications. An airdrop may be distributed for a variety of reasons, including marketing purposes, to raise funds, through an exchange, or after a hard fork.
The 2019 crypto guidance focused on airdrops as a result of a hard fork. The specifics of tax treatment for other types of airdrops remains unclear. Nonetheless, crypto holders should remember to report any income, gain, or loss from taxable transactions involving virtual currency in their tax return.
The IRS confirmed that new cryptocurrency received as a result of a hard fork is ordinary, taxable income. Keep in mind that you must report new cryptocurrency whether you asked for the airdrop or not.
The amount of income that you must report for new cryptocurrency is the cost basis of the crypto at the time that you received it. The cost basis can also be referred to as the fair market value.
According to the IRS, soft forks do not create income because no new cryptocurrency was received.
3. Calculating the cost basis of virtual currencies
Typically, to calculate the cost basis of cryptocurrency, you must sum up all the money spent to acquire the coins. This should include any fees, commissions, or other acquisition costs.
However, if you received crypto through an exchange or DEX, you could calculate the cost basis in other ways.
Cost basis for crypto received through exchanges
For coins you receive on a trading cryptocurrency platform you can calculate the cost basis through the platform.
When using an exchange, the cost basis of your cryptocurrency is the amount that the exchange platform recorded.
Cost basis for crypto from a peer-to-peer transaction
The process is different if you received crypto from a peer-to-peer transaction or peer-to-peer exchange. In the case of an audit, you must provide evidence of the cost basis to the IRS.
To establish the cost basis, you should use a cryptocurrency or blockchain explorer. This explorer should analyze worldwide indices of cryptocurrency and calculate the value at an exact date and time.
If you do not use the explorer’s cost basis, you must prove that the cost basis you choose is accurate.
4. Reporting crypto gains and losses – Accepted Accounting Methods
The recent IRS guidance also established that cryptocurrency will be treated as a capital asset. This means that capital gains rules apply to any gains or losses through sales or transfers. You need to report these gains or losses on Schedule D.
The 2019 IRS guidance also provided long-awaited guidance on accepted accounting methodologies. It confirmed that you can use specific identification, which may save significant tax for many traders. This gives crypto users now the option to decide between LIFO, FIFO and specific identification. You should talk to your accountant to discuss which accounting method is best for you.
5. No exemptions for small transactions
Furthermore, the IRS confirmed there are no exemptions for transactions below a certain threshold. Paying somebody for a service, even a coffee, will result in a capital gain or loss. This emphasized the IRS’s view that digital currencies are property (not currency) for tax purposes.
Record keeping for virtual currencies
Because of these reporting requirements, it is essential that you maintain excellent records. Cryptocurrency records should include documentation of:
- Other dispositions of your cryptocurrency
- The cost basis of your cryptocurrency
To identify a specific coin that was sold, you can use the unit’s digital identifier (If you don’t identify specific coins, FIFO automatically applies.). You can use any of the following to identify the coins:
- Private key
- Public key
- Records showing the transaction information for all units in a single account or address
You can use any of the above methods of identifying the crypto. However, regardless of how the coin is identified, you must include this information:
- Date and time each unit was acquired
- Cost basis of each unit at the time it was acquired
- Date and time each unit was sold, exchanged, or otherwise disposed of
- Fair market value of each unit when sold, exchanged, or otherwise disposed of
- Amount of money or the value of property received for each unit
Increased IRS focus on cryptocurrency
The 2019 IRS cryptocurrency guidance is only one of many signs that the IRS is increasing their focus on cryptocurrency.
In fact, in July of 2019, the IRS sent over 10,000 letters to taxpayers telling them that they might have a reporting obligation.
The IRS sent letters to individuals who may have incorrectly reported, underreported, or who did not report cryptocurrency at all. Taxpayers who did not report could incur taxes, penalties, interest, or even criminal prosecution.
Another recent sign of the IRS’s growing focus on cryptocurrency is the updated 1040 Form Schedule 1 for 2019. It includes a new question about cryptocurrency:
“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
The IRS’s recent actions emphasize the importance of making sure your cryptocurrency and taxes are in compliance.
2019 Cryptocurrency guidance – Opportunities for taxpayers
The IRS guidance provided much-needed clarity for the tax treatment of virtual currencies, especially when it comes to accounting methods. Allowing specific identification or LIFO will provide significant tax savings to many US taxpayers with cryptocurrencies.
A blog post like this can provide a good overview but cannot replace discussing your specific situation with a tax professional. Please talk to an experienced tax accountant to see if you should make any changes going forward and if you should consider amending prior returns.