We have been asked many times, about cryptocurrency and the taxes that result from these types of transactions and assets. Unfortunately, there is a lot of confusion and misinformation. Our goal is to give you a general idea of this new type of asset and how cryptocurrency is treated for tax purposes.
What is cryptocurrency?
A cryptocurrency generally refers to a digital token representing something intangible, such as a share in a decentralized network or ownership in a digital asset. There have been multiple cryptocurrencies through the decades which never got any traction until Bitcoin came around in 2009, solving the problems that existed with previous attempts to make a successful cryptocurrency. There are literally thousands of different cryptocurrencies, but some of the top cryptocurrency projects at the time of this writing include Ethereum (ETH), Binance Coin (BNB), Solana (SOL), Cardano (ADA), XRP, Terra (LUNA), Polkadot (DOT), Avalanche (AVAX), and more recently rising in popularity this year, Dogecoin (DOGE), Shiba Inu (SHIB), and Polygon (MATIC).
The IRS has ruled that, in general, a cryptocurrency (generally referred to as a “virtual currency” by the IRS) is treated as a capital asset (intangible property) rather than an actual currency. This is an important distinction because exchanging your US dollars for another true currency when you travel, such as the Euro, the Canadian Dollar, and the British Pound, generally does not result in a taxable transaction because it is just a straight-up exchange of one currency for another.
With cryptocurrencies, however, any sale or exchange is treated as the sale of a capital asset. When a capital asset is sold, it results in a capital gain or loss, which can be short-term or long-term, depending on your holding period.
Do I need to report the sale of a cryptocurrency on my US tax return, and is it taxable?
Since the IRS has ruled that virtual currency (or cryptocurrencies) constitutes a capital asset, the sale of a cryptocurrency (crypto) must be reported on your income tax return. The information you need is as follows:
- A description of what was sold (such as “1 Bitcoin”)
- The date of the sale
- The date you acquired the crypto
- the sales proceeds (your proceeds, net of commissions paid),
- the cost basis (what you paid for the crypto) the holding period
This information is reported on Schedule D and Form 8949, the same way as would be required with the sale of stock in a company.
Example 1: Satoshi purchased 1 Bitcoin on March 5, 2019, for $3,850. He sold the Bitcoin on April 13, 2021, for $60,000. Satoshi must recognize a capital gain on the sale of his Bitcoin of $56,150 ($60,000 proceeds, less $3,850 of cost basis). Because Satoshi held the Bitcoin for more than a year, this gain would be a long-term capital gain.
Example 2: Fred purchased 1 Bitcoin on January 1, 2021, for $29,500, and sold that Bitcoin on April 13, 2021, for $60,000. Fred must recognize a capital gain on the sale of his Bitcoin of $30,500 ($60,000 proceeds, less $29,500 of cost basis). Because Fred held the Bitcoin for less than a year, this gain would be a short-term capital gain.
If I exchange one cryptocurrency for another cryptocurrency, is that tax-free?
Since the IRS has ruled that virtual currency (or cryptocurrencies) constitutes the sale of a capital asset, the exchange of one crypto for another crypto (or for anything else) is treated as a sale, with the value of what was received in the exchange treated as the sales proceeds.
Example 3: Satoshi purchased 1 Bitcoin on March 5, 2019, for $3,850. On April 13, 2021, Satoshi exchanged his 1 Bitcoin for 26 Ethereum tokens, collectively valued at $60,000. The exchange of the Bitcoin for Ethereum is considered a sale of Bitcoin for the $60,000 worth of Ethereum received. The tax treatment, in this case, would be the same as in Example 1 (above).
Just to be clear, there is no such thing as a non-taxable exchange of one crypto for another crypto (a like-kind exchange). The only asset eligible for like-kind exchange treatment since the beginning of 2018 is real estate. Prior to that, certain other business assets could qualify for like-kind exchange treatment, such as trading in a piece of equipment toward the purchase of another piece of business equipment, but that is it. Any sale or exchange of digital assets, whether it is considered a cryptocurrency, a virtual currency, a non-fungible token (NFT), or any other digital asset, is treated as a sale for income tax purposes.
If I purchase a Non-Fungible Token (NFT) with my Ethereum or Solana, is that tax-free?
Again, since the IRS has ruled that virtual currency (or cryptocurrencies) constitutes the sale of a capital asset, the exchange of crypto for anything else (whether digital or physical) is treated as the sale for the crypto that was given up.
Example 4: Elliot purchased 26 Ether tokens for $60,000 on April 13, 2021. On June 1, 2021, Elliot exchanges his 26 Ether tokens for an NFT worth $100,000. The exchange of the Ether tokens is considered a sale of Elliot’s Ethereum for the $100,000 that the NFT was worth at the time of the transaction. The tax treatment, in this case, would be a capital gain of $40,000 ($100,000 of proceeds/ value received, less $60,000 of cost basis). Because Elliot held the Ether tokens for less than a year, this gain would be a short-term capital gain.
Can I spend my cryptocurrency, and is there any special tax reporting?
There are a number of credit and debit card providers that allow individuals to “spend” crypto that they hold in their accounts. This “spending” is done through an established payment network, such as a crypto Visa card, which allows the merchant to receive their payment in US dollars from Visa. The spending of crypto is treated as the sale of that crypto in exchange for the item received in the purchase and results in a capital gain or loss.
Example 5: Ben holds $400 worth of CRO tokens in his Crypto.com account, which he purchased for $100 on May 31, 2021. Ben has a crypto Visa card tied to his account, which he used to purchase $400 worth of groceries at the local supermarket on December 30, 2021. The $400 purchase of groceries is treated as the sale of $400 worth of CRO tokens, which results in a gain of $300 ($400 of proceeds, less $100 of cost basis). Because Ben held the CRO tokens for less than a year, this gain would be a short-term capital gain.
Cryptocurrency Disclosure on Individual Tax Returns
Ever since the IRS released the 2019 individual income tax return forms (1040 series forms), there has been a check box on the tax return that states, “At any time during 20XX, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”. You must answer this question correctly, and by signing or e-filing your tax return, you are attesting that this is answered correctly, under penalty of perjury. Make sure you do not try to hide the reporting of your cryptocurrency from the IRS.
Conclusion: Tax on Cryptocurrency
As you can see, there are many potential income tax pitfalls relating to cryptocurrencies. In general, the term “cryptocurrency” is somewhat of a misnomer because it is not actually treated as a currency. A more accurate way of thinking of cryptocurrencies is looking at them as digital assets. The sale or exchange of these digital assets constitutes the sale of a capital asset, and the gain or loss on the sale of the asset must be reported on your income tax return. There are many more nuances regarding the treatment and reporting of cryptos that are beyond the scope of this article. If you invest in or use cryptocurrencies, you should make sure you work with a competent tax professional familiar with the tax rules relating to cryptocurrencies.
At Cook Martin Poulson, we have several CPAs and other tax professionals who are experts in this area and are qualified to help you stay in compliance with the tax laws surrounding this relatively new asset class. We do not give investment advice or investment recommendations, but we can help you navigate through the complex compliance requirements surrounding these assets.