Anyone who uses or holds cryptocurrency should be aware that the IRS is beginning to require individuals to report it on the 1040 Tax Form. Cryptocurrency regulation has been an issue of debate for some time now, and the IRS is ramping up enforcement of crypto activity. 

Currently, tracking of all crypto asset activity is the responsibility of each individual taxpayer, as there are no 1099s for tracking those transactions as of yet. However, that will be changing in 2023, when a new 1099-K will be issued for crypto asset transactions totaling more than $20,000 in payments or 200 transactions.

With the rise in IRS regulation, it is important to keep detailed information on each crypto transaction, as it is taxable as capital gains or income, so that you can report any virtual currency on your taxes.

Do you have to report virtual currency on taxes?

The IRS has updated the box on the 1040 Tax Form asking, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”

Here are the general reasons to check Yes or No for this question:

Check YES if you participated in:

  • The receipt of virtual currency as payment for goods or services provided;
  • The receipt or transfer of virtual currency for free (without providing any consideration) that does not qualify as a bona fide gift;
  • The receipt of new virtual currency as a result of “mining” and “staking” activities;
  • The receipt of virtual currency as a result of a “hard fork”;
  • An exchange of virtual currency for property, goods, or services;
  • An exchange or trade of virtual currency for another virtual currency;
  • A sale of virtual currency; and
  • Any other disposition of a financial interest in virtual currency. 

Check NO if you participated in:

  • Holding virtual currency in the taxpayer’s own wallet or account;
  • Transferring virtual currency between wallets or accounts the taxpayer owns or controls; or
  • Purchasing virtual currency using real currency, including purchases using real currency electronic platforms such as PayPal and Venmo.

In summation, if you simply owned or purchased virtual currency but did not engage in any of the ‘Check YES’ items, you can check no on the 1040 Tax Form. 

What is considered virtual currency?

The IRS defines virtual currency as a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency (i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance), but it does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.

How does virtual currency affect taxes?

The tax burden from virtual currency depends on how the crypto assets will be used. For example, if Bitcoin is acquired from mining, the value of it is taxable immediately at the value it was mined at.

If Bitcoin is used by exchanging it for USD or exchanging it for goods and services, it is taxed on the realized value of the currency at the time of the transaction. This can be in the form of a capital gain long or short-term gain or loss in value. A long term is for those virtual currency held longer than a year while short term are for those held less than a year. It is very important to keep detailed records in case you are asked to prove this to the IRS. 

How is virtual currency taxed?

When it comes to how virtual currency is taxed, Cryptoassets may be considered capital gains, such as with a stock or bond, when sold or exchanged at a profit. Therefore, it is taxed at the standard capital gains tax rates. 

Capital gains tax rates for 2021

Long-term capital gains rate     Taxable income
Single filers
0% $0 to $40,400
15% $40,401 to $445,850
20% $445,851 or more
Married filing jointly
0% $0 to $80,800
15% $80,801 to $501,600
20% $501,601 or more

Source: IRS

Short Term – Marginal tax brackets for tax year 2021, single individuals

Taxable income Taxes owed
$0 to $9,950 10% of taxable income
$9,951 to $40,525 $995 plus 12% of amount over $9,950
$40,526 to $86,375 $4,664 plus 22% of amount over $40,525
$86,376 to $164,925 $14,751 plus 24% of amount over $86,375
$164,926 to $209,425 $33,603 plus 32% of amount over $164,925
$209,426 to $523,600              $47,843 plus 35% of amount over $209,425
$523,601 or more $157,804.25 plus 37% of amount over $523,600

Source: IRS

Can you deduct crypto losses?

Yes, you can deduct losses in virtual currency on your taxes as a capital loss.

With the volatile nature of virtual currency, there is both opportunity for great gains and also great losses. Be sure to report any losses that have been realized as they can be used to offset any gains you have made in other investments. 

What happens if you don’t report virtual currency on your taxes?

It is important to report crypto asset activity accurately on this on the 1040 tax form. In the case of an audit, there may be fines, penalties, or even criminal charges, depending on the severity of the offense.

The IRS is just brushing the surface of virtual currency reporting compliance and enforcement. It’s likely that it will become more structured as time goes by.

While dealing in virtual currency can be exciting, it does also have challenges. Just remember to keep detailed records in all your crypto asset dealings to support any claims that might need to be tracked.

We are here to help with questions regarding reporting virtual currency. Contact Tolbert CPA.