Frost Law
As the world of cryptocurrency continues to evolve, new regulations and laws will continue to be updated and added at a state and federal level.
Following these changes can be challenging, which is why we recommend that you have our team of knowledgeable tax professionals to help you untangle the web of cryptocurrency tax. Our team is made up of tax attorneys, certified public accountants, and other tax professionals who all have years of experience guiding on complex tax issues.
Our tax team has taken the initiative to answer a few frequently asked questions regarding cryptocurrency. If you would like more information about cryptocurrency tax contact our team today at (410)-497-5947 or fill out our brief contact form.
In Notice 2014-21,¹ the IRS provides guidance on the application of existing general tax principles to virtual currency transactions. The guidance is clear that for federal income tax purposes, virtual currencies are treated as property. In other words, general tax principles that are applicable to property transactions apply to virtual currency transactions. Thus, a taxpayer has a taxable gain from a virtual currency transaction “[i]f the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.”² The guidance also clarifies that virtual currencies cannot generate foreign currency gain or loss for U.S. federal income tax purposes.
Short-term capital gains, or virtual currencies held for a period of less than one year are taxed at the ordinary income tax rate. Long-term capital gains taxes are applied when virtual currencies are held for more than one year.³
Yes, the guidance is clear that for federal income tax purposes, virtual currencies are treated as property. In other words, general tax principles that are applicable to property transactions apply to virtual currency transactions. Thus, a taxpayer has a taxable gain from a virtual currency transaction “[i]f the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.”⁴ The guidance also clarifies that virtual currencies cannot generate foreign currency gain or loss for U.S. federal income tax purposes. In Notice 2014-21,⁵ the IRS provides guidance on the application of existing general tax principles to virtual currency transactions.
Taxpayers who make coin-to-coin trades have mistakenly believed that there is no tax liability in trades. However, because the IRS treats virtual currency as property, these trades are subject to capital gains and losses tax treatment.
In Notice 2014-21,⁶ the IRS provides guidance on the application of existing general tax principles to virtual currency transactions. The guidance is clear that for federal income tax purposes, virtual currencies are treated as property. In other words, general tax principles that are applicable to property transactions apply to virtual currency transactions. Thus, a taxpayer has a taxable gain from a virtual currency transaction “[I]f the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.”⁷ The guidance also clarifies that virtual currencies cannot generate foreign currency gain or loss for U.S. federal income tax purposes.
Taxpayers have tried to delay capital gains by classifying virtual currency traded for alternative virtual currencies as like-kind exchanges. A taxpayer is generally not required to recognize a gain or loss as a result of a like-kind exchange under Internal Revenue Code (IRC) §1031. Significantly, IRC §1031 was amended by the Tax Cuts and Jobs Act of 2017, such that nonrecognition of gain or loss is only applicable to real property exchanges completed after December 31, 2017. After December 31, 2017, IRC §1031 does not apply to cryptocurrency exchanges. This means that cryptocurrencies exchanged or traded for like-kind cryptocurrencies will not receive the like-kind exchange nonrecognition benefit.
A taxpayer cannot cash out on virtual currencies without tax. A taxpayer who cashes out, or sells, a coin position must report a capital gain on Form 8949 to the Internal Revenue Service (IRS).
The IRS stated that "taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest." The IRS continued by warning taxpayers that they could even face criminal prosecution for failing to properly report virtual currency transactions. Tax evasion and filing a false tax return were listed as criminal charges a taxpayer may confront. The penalties for either of these charges are heavy. The IRS explained that "anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000."
In Notice 2014-21,⁸ the IRS provides guidance on the application of existing general tax principles to virtual currency transactions. The guidance is clear that for federal income tax purposes, virtual currencies are treated as property. In other words, general tax principles that are applicable to property transactions apply to virtual currency transactions. Thus, a taxpayer has a taxable gain from a virtual currency transaction “[i]f the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.”⁹ The guidance also clarifies that virtual currencies cannot generate foreign currency gain or loss for U.S. federal income tax purposes.
For federal income tax purposes, virtual currencies are treated as property. In other words, general tax principles that are applicable to property transactions apply to virtual currency transactions. A taxpayer has a taxable gain from a virtual currency transaction “[i]f the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency.”¹⁰
Thus, when filing your tax returns on virtual currencies a taxpayer must fill out a schedule D Form 1040, Capital Gains and Losses.
Unlike with the sale of stocks or bonds, in which case a brokerage firm will send the taxpayer a Form 1099 Miscellaneous Income, the taxpayer will not receive notice from Coinbase (the database which tracks sales of virtual currencies) on the sale or trade of virtual currencies unless they have realized $20,000 or had at least 200 transactions.
