Trying to understand cryptocurrency taxes and how the IRS will treat your Bitcoin, Ethereum, and Litecoin? You’re far from alone.
If you have been following the investment news in recent months, it may have been hard to ignore cryptocurrency’s rise and fall in popularity.
Cryptocurrency Taxes Obligations
In recent years, both Bitcoin and Ethereum broke record highs. With such headlines, more American investors are being lured into adding cryptocurrency into their portfolios. 14 percent own cryptocurrency right now and many others are considering it as their first investment move.
As with any other investment (such as investing in real estate), cryptocurrency investors are now being called upon to keep up with their tax obligations. So how do you pay tax on virtual currency?
Here’s the must-know basics about IRS taxation of cryptocurrencies.
Do I Need To Declare a Cryptocurrency Investment?
The short answer is, yes. All U.S. citizens are required to report any amount of cryptocurrency they may have bought, sold, or mined.
This is evident in the IRS’s recent amendment to Form 1040, where they moved the question, “At any time during [the tax year], did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” to a more prominent place in the document.
Now, the question comes on page 1 of your personal tax return, right after your name and address, highlighting the IRS’s eagerness to clamp down on tax evasion/omittance for cryptocurrency.
While you may not be liable for tax on your cryptocurrency investment (if no activity took place), you are still required to declare all amounts of virtual currencies on your 2020 tax return. So even if you had no taxable event for cryptocurrencies, you should still answer “yes” to the question on your tax form.
Failure to report it could lead to severe penalties from the IRS, including sizeable fines, and potentially, felony charges.
How Is Tax Calculated On Cryptocurrency?
Based on a 2014 ruling, cryptocurrency is treated as a capital asset for tax purposes. Put simply, that means the IRS treats it as property.
The levying of IRS charges on virtual currencies is calculated using the difference between the price at which you bought and sold your cryptocurrency, instead of the static value of your holdings. Keep in mind, taxable events for cryptocurrency investments also cover whether you trade your virtual currency for another virtual currency.
The tax you pay on the profit realized will depend on how long you have held your cryptocurrency investment. Similar to stock investments, gains on cryptocurrency held for 12 months or less will be taxed as short-term capital gains. This means it will get treated the same as your active (“earned”) income. Based on your income bracket for the year, you could pay up to 37 percent in federal tax.
However, if you hold your cryptocurrency for more than 12 months, you will get taxed at the lower long-term capital gains tax rate of only 0, 15, or 20 percent.
Finally, as with other investments, you can carry over any loss you incur on the sale of your cryptocurrency up to a maximum amount of $3,000. There is no time limit for carrying over this loss.
Will The IRS Know If I Invest In Cryptocurrency?
Yes, the chances are they will. In a bid to uncover cryptocurrency tax evasion and non-reporting, the IRS has moved to compel several virtual currency platforms to share customer information with them.
A good example of this has been the recent court ruling authorizing the IRS to serve a ‘John Doe Summons’ to Kraken and Circle Internet Financial. The IRS is asking for information that will uncover the identities of investors who conducted at least $20,000 in cryptocurrency transactions between 2016 and 2020.
Others like Bitpay comply with Section 6050W of the Internal Revenue Code, which means they share information with the IRS using Form 1099-K.
Plus, in 2019, the IRS Commissioner acted to accelerate criminal investigations of digital currencies. As part of this effort, the IRS sent out letters to 10,000 taxpayers believed to hold cryptocurrency positions. Recipients of these letters who had misreported their cryptocurrency holdings were required to amend past returns, as well as pay back taxes, interest and penalties.
Therefore, it is always advisable to report your cryptocurrency transactions to the IRS if you choose to invest.
The Bottom-line about Cryptocurrency Taxes
If you still have more questions about your virtual currency tax obligations, it may be time to speak to a tax professional to understand how an investment in the market’s hottest currency can affect your tax situation.