By Patty Remmell, BridgeTower Media Newswires
Whether you’re deep into virtual currency, just dabbling, dipping your toes in or simply crypto curious, know this: exchanging virtual currency is a taxable event. And, as we approach the end of the year, it’s important to understand the tax implications while there’s time to improve your position or reduce your liability. But first, a quick overview.
What is virtual currency?
An online (aka “digital”) asset that represents value in real currency and can be used instead of hard money. Cryptocurrency, the most well-known type of virtual currency, encrypts transactions and records them in code on a public, distributed digital ledger called a blockchain. Bitcoin (the first crypto currency) and Ethereum are practically household names, but there are thousands of other types of crypto available today. Note: All virtual and cryptocurrencies are digital currencies — available online in electronic form only — but not all digital currencies are virtual or crypto. In this article, we’ll focus on crypto.
How is cryptocurrency made?
New units are created as payment for successfully verifying transactions through a process called mining. Crypto miners harness immense computer processing power to solve complex math problems that verify blocks of transactions before they’re added to a blockchain. In exchange, they receive new units of crypto, which is how they’re generated and released.
Where do I get virtual currency?
You can buy, sell and trade virtual currency on a crypto exchange, which is a marketplace similar to an online brokerage platform. Binance, Coinbase, Crypto.com and Kraken are some of the top exchanges by volume.
Why should I care about virtual currency?
Because it’s not going away. Though the business world is still in the early adoption phase, we’re seeing more and more companies accepting virtual currency, paying vendors and employees with it, and using it to buy space in the metaverse. At the same time, more and more individuals are investing in virtual currency and buying and selling goods and services with it.
Sure, the crypto players, exchanges and brands will evolve and narrow, but eventually virtual currency will be commonplace in your personal and business circles if it’s not already. In the last year at MMB for example, the number of our clients who use or invest in virtual currency has increased significantly. Nationally and globally, Statista and Crypto.com report:
- The number of crypto users increased 190 percent from 2018-2020 and nearly as much 2021, with big companies like Mastercard, Coca Cola, Home Depot and Microsoft accepting Bitcoin payments.
- About 1 billion people will use crypto by the end of 2022.
- Approximately 16 percent of US adults have invested in, traded or used crypto.
- There are more than 10,000 types of crypto, but only a handful make up 90 percent of the total market share.
- The global crypto market cap was $1.06 trillion in August; by 2025, it’s estimated to be $39.17 billion.
Buyer, investor & user be aware: The tax implications of virtual currency
Crypto newbies are often surprised by the tax consequences of exchanging virtual currency. If you primarily invest in stocks and bonds but are thinking about or dabbling in virtual currency, give some thought to the following information before the end of the year.
The IRS treats virtual currency as property
Since virtual currency is considered a capital asset for tax purposes, you’ll realize a gain or loss when you exchange it. That could be to buy and pay for a product or service. Or, like stocks and bonds, when you trade one type of virtual currency for another or transfer it to hard currency. These are all considered “taxable events.”
Wages paid in virtual currency must be reported
If your salary is paid in virtual currency, you’ll need to report it on your taxes just like income paid in dollars. Same for payments you receive if you’re an independent contractor, self-employed or have a side gig.
Virtual currency is volatile
The value of virtual currency fluctuates significantly more than the dollar and other hard currency. Like other types of property its value is based on supply and demand, but unlike more predictable asset supplies, crypto mining is unpredictable, so availability spikes up and down unexpectedly. If someone suddenly mines a large amount of a Bitcoin, for example, its value will drop rapidly. You just don’t get those wild swings with traditional currency.
Peace-of-mind point: If you’re holding onto virtual currency as an investment, don’t worry about immediate tax implications if its value skyrockets or sinks. It doesn’t become a taxable event until you give up ownership by trading or selling. At that time, you’ll realize a capital gain or loss that impacts your tax liability.
Fair market value is what counts
When filing your taxes, you’ll need to know the fair market value of the virtual currency in US dollars as of the date of the taxable event. If the virtual currency is listed on a crypto exchange, just convert it into dollars at that day’s listed exchange rate. You may need to do a little digging to find the data though, because the exchanges don’t always provide detailed reporting.
Pro tip: Download and print the data from the exchange and then next to the date of the transaction, jot down the type of transaction and the day’s exchange rate.
If it’s a rare case when the virtual currency is not on an exchange, it’ll be more challenging to determine the fair market value at the time of a transaction. Best bet: Keep detailed records noting what you exchanged, when and why, and consult with your tax advisor.
Dates and times matter
If you receive virtual currency as payment, its fair market value is based on the exchange rate the day and time you got it. When you trade or exchange the virtual currency in the future, you’ll realize a capital gain or loss depending on whether its value increased or decreased during the “holding period” — the time from when you got the currency until the day of the taxable event.
Important note: If you receive virtual currency as a gift, the holding period goes back to when the person who gave it to you acquired it.
Holding periods impact gains and losses
As with any type of capital asset, selling or exchanging virtual currency after holding it a year or less results in a short-term capital gain or loss. If you held it longer than a year, you’ll have a long-term capital gain or loss. Short-term gains are taxed at the same rate as your regular income tax bracket. Long-term gains are taxed at 0 percent, 15 percent or 20 percent, depending on your income.
Most transactions are taxable events
Trading, buying, selling, mining, using as payment and cashing out virtual currency are all taxable events. So is an “air drop,” which is when newly mined units of a cryptocurrency are distributed to investors in that type of crypto automatically. Though the investors receive the airdropped currency for free, they need to report it as income.
Some transactions are not taxable events
Virtual currencies are not taxable when gifted — as stocks and bonds are — but are subject to taxes when they’re exchanged in the future. Transferring virtual currencies between your own digital wallets and accounts is also not a taxable event. And if you want to impress your friends at the next cocktail party, tell them “hard forks” and “soft forks” aren’t taxable events either. These funny-named scenarios occur when a cryptocurrency undergoes a protocol change. In the case of hard forks, the change requires all future transactions to be recorded on a new ledger as a new cryptocurrency. A soft fork is when the change does not require a new ledger or cryptocurrency.
Reporting income, gains, losses: There’s a form for that
Income: Report all income received in virtual currency on Form 1040 Schedule 1 (“Additional Income and Adjustments to Income”), except for self-employment earnings, which go on Schedule C (“Profit or Loss from Business”)
Capital gains and losses: Complete Form 8949 (“Sales and other Dispositions of Capital Assets”) and report the totals on Schedule D (“Capital Gains and Losses”)
Note: There’s no specific guidance about which Form 1099 crypto exchanges need to provide, if any, so don’t wait for or rely on a 1099 when filling out your tax forms. Use Form 8949 instead.
Act now to reduce your tax liability later
Now’s a good time to look at your portfolio for 2022 to see if there are steps you can take to lower your tax bill—or at least plan for it. Like the way people make end-of-year charitable donations that reduce their taxable income, you can exchange virtual currency to realize a loss that lowers your liability. At the same time, if you’ve realized a gain over the course of the year by exchanging virtual currency for a higher value than you received it, it’s good to know that too. Your tax consultant can help you figure out how your capital gains or losses will impact your overall tax position for the year.
Recordkeeping is your friend
When filing your taxes, you’ll need to calculate the fair market value of your virtual currency for all taxable events and from there, determine capital gains or losses. Your tax advisor can help you, but only if you provide the details. So be sure to download the data from the exchanges and track your transactions noting the date, time, exchange rate, what you did and why.
Carry on with confidence
While it’s important to understand the tax implications of virtual currency, you don’t need to second-guess every decision. Just make sure you know the guidelines and consider consulting with a tax professional. Because even for a seasoned investor, the tax complexities can be daunting. It pays to talk to a CPA or tax advisor any time you buy, sell or exchange virtual currency—and definitely before the end of the year.
Anthony R. Scinto, CPA, is a Tax Partner and Chair of the Tax Department at Mengel Metzger Barr & Co.