In mid-October 2019, the IRS released new rulings regarding how virtual currency is viewed in light of tax law.
The main takeaway is this: If you’ve got crypto, the IRS is keeping a close eye on you. There’s no need to panic! Here at Robert Russo CPA, we’ve put together 4 things you need to understand about taxes on cryptocurrency – and how the new October ruling impacts you.
The IRS is being transparent in their efforts to collect taxes on cryptocurrency. They’ve released a FAQ sheet, and have sent 10,000 letters out to folks who may not have realized they needed to pay taxes on virtual currency. In fact, a client of ours received one of these letters. We worked with him to amend his return, pay the proper taxes, and all is well.
1) New Form 1040 Contains One VERY Important Question Related to Taxes on Cryptocurrency…Answer it Honestly!
“At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in virtual currency?”
If all goes according to plan, that will be question #1 on the top of the 2019 version of the IRS’s 1040 form. You’re required to answer yes or no, under the penalty of perjury. After all, the IRS wants to collect taxes on cryptocurrency and they can’t do that without knowing if you’ve had a taxable event.
That means if you were paid for work in the form of cryptocurrency, you need to check the “yes” box. If you cashed in Bitcoin for good, old-fashioned American dollars – that’s an exchange and it’s “yes” box for you. When in doubt of which box to check, reach out to a qualified CPA. Answering “no” when it should be “yes” could result in criminal penalties!
Many tax experts have noted this verbiage echoes the question about whether you hold accounts in foreign countries. This question aided the IRS in hunting down offshore accounts. It’s clear the IRS is now looking to track down those who are avoiding taxes on cryptocurrency.
Now, here’s where things get tricky. Let’s say you acquired a handful of virtual currencies in 2018. You haven’t done anything with those currencies in 2019, so you’re good…right? You can answer “no” on the form, and not pay any taxes on cryptocurrency! Not so fast…
If one of those virtual currencies executed what is known as a “hard fork” with an “airdrop” into your account in 2019, you have to pony up for taxes on cryptocurrency.
2) Assess Each Cryptocurrency You Own: Where There Any Hard Forks with an Airdrop Into Your Account?
A hard fork is very similar to when a traditional stock undergoes a “split.” When a stock split occurs, it’s like getting free extra stock in the new company – and you don’t have to pay any taxes. However, you do owe taxes on cryptocurrency if a hard fork with an airdrop occurs.
In the crypto world, a hard fork refers to when one single virtual currency splits into two separate forms of currency: an old one, and a new one. When this split happens, the new currency is recorded on a new distributed ledger. The prior currency continues to record transactions on the prior ledger.
If you’re holding a currency that experiences a hard fork, typically you will automatically receive the new currency via an airdrop into your account. And the IRS considers that a taxable event…you will owe taxes on cryptocurrency you have received.
Of course, things are about to complicated once again when it comes to taxes on cryptocurrency. If one of the currencies you hold executes a hard fork but does NOT immediately airdrop to your account, you’re off the hook tax-wise – until that currency arrives into your account. The IRS even includes this in their FAQ.
The IRS also makes it clear that soft forks do not result in a taxable event. A soft fork is when there are big changes in a ledger, but no new currencies are created. So you’re safe from taxes on cryptocurrency in the instance soft forks, hard forks without airdrops, and on one more occasion…
3) You Don’t Need to Pay Taxes on Cryptocurrency if it’s Received as a Gift…But if You Sell or Exchange it, That’s a Different Story
It’s not a taxable event if someone gives you cryptocurrency. However, if you decide to sell or exchange it, you’ll definitely pay taxes on cryptocurrency if you have a gain. It’s important to note here that the IRS treats cryptocurrency like property, so things like “basis” and FMV (fair market value) come into play just as they would if you were selling stocks or artwork that you were gifted.
Again, the IRS has provided guidance on how to determine gain and loss related to taxes on cryptocurrency.
You’ll have a loss if the following is true: your basis at the time of sale is equal to the lesser of A) the market value of the cryptocurrency at the time you were given it OR B) the donor’s basis.
Or, you’ll have a gain – and need to pay taxes on cryptocurrency – if this calculation applies to you: your basis when you sell the currency is equal to your donor’s basis.
Now, what if you can’t find details on the value of the cryptocurrency at the time you were given it? This is a common occurrence, and the IRS states that your basis is therefore zero.
If you’re overwhelmed with this information regarding taxes on cryptocurrency, it’s critical that you reach out to a qualified CPA with proven experience in virtual currency. Our entire team is staying on top of the IRS rulings and regulations related to taxes on cryptocurrency. As always, get in touch with us if you have any questions!