FAQ: How Is Virtual Currency Taxed
Virtual currency — often referred to as “bitcoin” — is a mystery for many people but an everyday currency for others. As virtual currency grows in popularity, questions arise about its taxation. The IRS treats virtual currency as property and not as currency. This means that general tax principles that apply to property transactions apply to transactions using virtual currency.
What Is Virtual Currency?
Virtual currency is a type of digital currency that operates as a store of value, exchange medium or unit of account. Most virtual currency types have been created to replace government-issued currency in buying services and goods in the real economy. Bitcoin is one example.
A 2015 federal government report described how virtual currency is generally obtained. An individual can exchange conventional money for virtual currency, obtain virtual currency in exchange for the sale of goods or services or acquire virtual currency by serving as a “miner.” This approach requires significant computer processing power. While virtual currency may operate like “real” money, it does not have legal tender status in the U.S.
IRS Guidance
In Notice 2014-21, the IRS announced that it will treat virtual currency, officially referred to as digital assets, as property. The IRS explained that transactions using virtual currency must be reported in U.S. dollars for U.S. tax purposes. Taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.
If a virtual currency is listed on an exchange and the exchange rate is established by demand and supply in the market, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency, which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied, the IRS explained.
In regard to paying taxes on crypto gains, taxpayers must report any income related to transacting in digital assets. If an investor transfers, sells or exchanges a digital asset, they must figure out their gains and account for them when making IRS returns. The same applies to writing off crypto losses, where the capital loss on a digital asset transaction must be reported as a capital loss. To calculate a loss or gain on your digital asset, you will require this information:
- The digital asset type
- Time and date of the transaction
- Basis of the sale or disposal of the digital asset
- Total number of units
- Fair market value in U.S. dollars when the transaction was done
Which Virtual Currency Transactions Are Taxable?
The IRS sets clear guidelines on how taxpayers should handle virtual currency. You are not expected to pay taxes for:
- Only holding your virtual currency in an account or wallet without making any transaction.
- Buying digital assets and not selling them.
- Transferring digital assets from one account or wallet you own to another that you also own.
However, you must pay taxes for making digital asset transactions, such as:
- Using virtual currency to pay a transfer fee.
- Transferring financial interest or ownership of a digital asset.
- Exchanging one digital asset for another.
- Buying goods, services or property for virtual currency.
- Exchanging digital assets for U.S. dollars or other currency.
- Receiving virtual currency as an award or reward, an airdrop, staking and mining, or a payment for providing goods, services or property.
If an employee or digital contractor is paid using virtual currency, they should report the value of the payment as wages.
More Changes Possibly Coming
In November 2016, the Treasury Inspector General for Tax Administration (TIGTA) asked the IRS to review its approach to virtual currency. The IRS has established a virtual currency task force, but TIGTA reported that the IRS could better coordinate some of its intra-agency activities. TIGTA also found that while businesses and employers must report taxable virtual currency transactions, third-party information reporting documents did not provide the IRS with any means to verify whether the reported amounts were particularly related to digital assets.
TIGTA suggested that the IRS provide updated virtual currency guidance and revise reporting documents related to third-party information to determine the amounts of virtual currencies used in transactions that count as taxable. The IRS accepted the recommendations. Since then, the IRS has made several developments, and more guidance will be issued.
Connect With Us for Assistance With Virtual Currency Taxation
At Marshall Jones, we provide professional tax and accounting services to clients in Atlanta, GA. We will help you navigate the complexities of understanding taxes on digital assets, like reporting gains from Coinbase transactions and IRS guidelines on this process, to ensure you are compliant. Contact us today if you require personalized assistance with your virtual currency taxation needs.
