With the tax deadline just weeks away – tax day is April 18 – taxpayers are scrambling to complete and file their returns. One thing that can cause confusion this year? Cryptocurrency. While not a new tax topic, conflicting loss advice and different wording on Form 1040 cause headaches. Here are five things you need to know about cryptocurrency before you file your tax return.
Check the box
The IRS takes cryptocurrency, uh, digital assets seriously. This year, the question at the top of your Form 1040 asks: “At any time in 2022, did you: (a) receive (as an award, reward, or payment for goods or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or financial interest in a digital asset)? »
According to the IRS, “digital assets are any digital representations of value that are recorded on a cryptographically secured distributed ledger or similar technology.” This includes non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins.
And just in case there’s any confusion, the IRS notes that “if a particular asset exhibits the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.” In other words, if he looks like a duck, walks like a duck, and quacks like a duck, he might just be a duck.
Not all digital asset transactions require you to tick the yes box. For example, simply holding a digital asset in one wallet or account, or transferring a digital asset from one wallet or account that you own or control to another wallet or account that you own or control n does not result in a yes. It also does not include the purchase of digital assets in cash or another currency, including through the use of electronic platforms such as PayPal.
Don’t leave the question unanswered. All taxpayers must check a box, not just those who made a transaction involving digital assets in 2022.
Income is income
This is true no matter what the income looks like once it comes to you. This means that receiving cryptocurrency or other digital assets in exchange for services is considered income. This includes income earned as an employee or as an independent contractor.
Revenue from mining and staking may also be recognized. And if a hard fork is followed by an airdrop and you receive new cryptocurrency, the IRS considers it taxable income.
But not all transactions give rise to the recognition of income. If your cryptocurrency went through a hard fork and you did not receive any new cryptocurrency, you have no taxable income to report. Similarly, a soft range will result in no taxable income.
Cryptocurrency is property
The IRS considers cryptocurrency as capital. The agency issued guidelines in 2014, making it clear that capital gains rules apply to any gain or loss.
- If you buy and sell cryptocurrencies as an investment, you will calculate gains and losses the same way you buy and sell stocks.
- If you treat cryptocurrency like cash – spending it directly on goods or services, or using it to buy other digital assets – individual transactions can result in a gain or loss.
For tax purposes, you calculate your capital gains or losses by determining how much your basis – generally, the cost you pay for the assets – has increased or decreased between the time you acquired the asset and the time until to a chargeable event. A taxable event may include a sale, gift or other disposition.
If you hold an asset for more than a year before a taxable event, it is considered a long-term gain or loss. And if you hold an asset for a year or less before a taxable event, it’s considered a short-term gain or loss.
And while cryptocurrency goes up and down, you care the most about the beginning and the end – what happens in the middle doesn’t really matter. This is because for tax purposes, when the cryptocurrency dips, it does not equate to a realized loss. Likewise, when it goes up in value, it does not equate to a realized gain. To realize a gain or loss for tax purposes, you must do something with the asset, such as sell it or otherwise dispose of it.
At tax time, you will report all realized gains and losses on Schedule D. You do not need to file a Schedule D if you have no realized gains or losses, even if the value exchange, if there is no sale or disposal, there is nothing to report.
Losses can be limited
As with other capital assets, if realized losses on digital assets exceed realized gains, you will incur a capital loss. You can claim up to $3,000 (or $1,500 if you’re married and filing separately) in capital losses in a tax year—the amount of your loss offsets your taxable income. However, if your losses exceed these limits, you can carry them forward to future years, subject to certain limits and restrictions.
Here’s how it works. Let’s say you realized $3,500 of net capital losses in 2022. You can deduct $3,000 of capital losses for the 2022 tax year – the return you file now – and carry forward the remaining $500 of losses to use on next year’s tax return.
Something is not nothing
There has been a lot of speculation on how to deal with the cryptocurrency which has rapidly declined in value to almost worthless. Specifically, it has been suggested that if the value of your cryptocurrency has dropped significantly, you can report it as a loss under Section 165.
In January, the Office of the Chief Counsel for the IRS released Memorandum 202302011. The “non-taxpayer-specific guidance” confirmed two things:
- If you lose most of the value of your cryptocurrency, it is not worthless, it still has value. This means that you have no sustained loss under section 165.
- Even if you suffered an actual loss under section 165, the loss would be disallowed because section 67(g) suspends various itemized deductions for the 2018 through 2025 tax years (certain exceptions apply).
The memorandum refers to Lakewood Assocs. v. Commissioner, 109 TC 450, 459 (1997), stating that “the mere decrease in the value of property does not create a deductible loss”. In other words, if it’s not totally worthless, you still own something and there is no realized loss.
It should be re-emphasized that the IRS memo is a response to a “request for a non-taxpayer-specific advice”, which means it “should not be used or cited as precedent.” . It does not have the same weight as a law or a regulation. However, it does offer some insight into how the IRS views an issue, and it’s valuable information.
Here is a quick overview of some of the most common questions about cryptocurrency. There are certainly more complicated cryptocurrency scenarios that are not covered here.
If you’re looking for more information, the IRS has digital asset-specific links and FAQs on its website. And while the internet can offer some helpful advice (hey, you’re reading this right now), not all cryptocurrency tax advice is created equal. If you have any questions, I strongly recommend that you consult a competent tax professional.