How to Report Virtual Currency on Your Tax Return
Here we are in tax season and there is always something new for us to learn about or remember. This year is no exception. Along with these important changes you need to know, millions of people will need to report their virtual currency (also called cryptocurrency or digital currency) for the first time.
A question about cryptocurrency is on the front page of your tax return (Form 1040.) It requires a “yes” or “no” response. However, the way you respond can be complicated. We will get into that – but first, let’s review the basics.
What is cryptocurrency?
A simple definition is that cryptocurrency is a digital or virtual currency that is nearly impossible to counterfeit and allows for secure online payments.
Cryptocurrency is a form of digital asset based on a network distributed across a large number of computers. It is decentralized digital money based on blockchain technology.
There are more than 5,000 cryptocurrencies in circulation. You may have heard of the most popular versions: Bitcoin and Ethereum.
How (and where) you can get cryptocurrency
Investors get cryptocurrency in 3 ways:
1. Crypto exchanges like Coinbase
2. Apps like Cash App
The most common ways to invest in cryptocurrency
You can invest in virtual currency using one of the methods listed above. There are a few other popular options:
1. Financial derivatives like CME’s Bitcoin Futures
3. Bitcoin ETFs
You can read more about what cryptocurrency is in this article from Forbes.
How do you answer the question about cryptocurrency on a tax return?
As more and more people enter the world of virtual currency, the IRS is becoming increasingly diligent about the need to correctly report this asset.
The question on the tax return reads:
At any time during 2021, did you receive, sell, exchange or otherwise dispose of any virtual currency?
If you buy or hold cryptocurrency, you are not necessarily required to answer “yes.” Also, if you answer “yes,” it does not mean that you will be taxed. Here are general points to consider when choosing how you will respond.
Answer “yes” about virtual currency if any of the following apply:
You sold, mined, or exchanged digital assets
You made purchases with cryptocurrency
You received cryptocurrency for free or as payment for goods or services
You exchanged one crypto for another
You disposed of a financial interest in a virtual currency
Answer “no” about virtual currency if any of the following apply:
You only purchased cryptocurrency
You only hold crypto in wallets or accounts
You only transferred digital currency between self-owner or self-controlled wallets or accounts
You did not make any sales or earn any income from your crypto
However, if you answer “no” and the IRS finds that there was taxable activity, you will have lied on a government document and there are harsh consequences. You may face penalties, interest, or criminal charges as it may be considered tax evasion, tax fraud, and/or perjury.
This article from CNBC discusses the consequences for failing to report cryptocurrency – and reinforces why it’s important to report it correctly.
How are you taxed for cryptocurrency?
Determining your taxation for cryptocurrency can be challenging! If you hold on to your digital currency for long enough, you could qualify for long-term capital gains and lower income tax rates.
With virtual currency, most exchanges occur more frequently, which means investors have short-term capital gains at regular income tax rates. You can figure out capital gains for both the short and long term using this calculator from NerdWallet.
Tax rates for cryptocurrency are largely based on the following:
Gain or loss from your purchase price (the basis)
Value when selling or exchanging
Length of ownership
Virtual currency is generally considered taxable when it is:
Exchanged or sold for a profit
Swapped with other digital coins
Cashed out for U.S. dollars
Used to make a purchase
Read more about how crypto investors can calculate your tax bill here.
In Conclusion
Due to the complicated nature and the severe consequences, it is recommended that you work with a trusted CPA.
The information in this article is for informational purposes only. The article provides background information to help readers correctly answer the virtual currency question on their 2021 tax returns. This article is not intended to use as a source for making financial or investment decisions of any kind. If you are interested in investing in cryptocurrency, it is recommended that you meet with a certified financial planner.