Welcome to WCS Money Tutorials.
Today’s topic is “How Cryptocurrency Is Taxed”.
Cryptocurrency is usually taxed as capital gains, but in certain cases it may be taxed
as ordinary income and may even be subject to employment or self-employment taxes.
Special rules apply to cryptocurrencies received as a gift.
Under the federal tax code, cryptocurrency, sometimes called virtual currency, is treated
as property, so most tax rules that apply to property sales also apply to cryptocurrency
transactions.
The value of cryptocurrency in a transaction is its fair market value in dollars when the
transaction takes place.
Because cryptocurrencies are treated as property rather than securities, the wash sale rules,
which disallows claiming losses for securities repurchased within 30 days of the sale, do
not currently apply, as of December 2021, but this may soon change.
However, the economic substance doctrine may apply. Losses from a transaction taken solely to claim a loss may be disallowed.
In most transactions, cryptocurrencies are considered a capital asset.
However, cryptocurrencies are not capital assets for businesses that hold cryptocurrencies
as inventory or receive cryptocurrency as payment.
The tax basis of the cryptocurrency is the amount paid for the cryptocurrency minus expenses
for acquiring the cryptocurrency, including fees, commissions and other acquisition costs.
The holding period for cryptocurrency begins the day after it is received.
The holding period ends when the cryptocurrency is disposed of.
The long-term capital gains rate applies to cryptocurrencies held longer than 1 year.
Interest earned from cryptocurrencies is treated like interest earned from other investments,
so it is taxed as ordinary income.
Airdropped currency is also taxed as ordinary income, equal to the fair market value of
the cryptocurrency when it is received, but only if you have control over selling or otherwise
disposing of it.
The taxation of cryptocurrency received as gifts is the same as for other property received
as gifts.
The holding period began when the donor received it, if the donee has documentation to support
it; otherwise, the holding period begins the day after the donee receives the gift.
When you dispose of the gift, if you have a gain, then your basis will equal the donor’s
basis + any gift tax the donor paid for the gift.
If you have a loss, then your basis equals the lesser of the donor’s basis or the fair
market value of the cryptocurrency when you received it.
If the donor’s basis cannot be substantiated, then your basis is 0.
Donations of cryptocurrency are tax-deductible under the same rules as with donating property.
If you receive new coins because of a hard fork in a blockchain, then you may have taxable
income if they have a readily ascertained market value.
Soft forks do not result in the creation of new cryptocurrency; therefore no income is
received from soft forks.
Recipients of airdrops, which are promotional distributions of coins or tokens to promote
a new cryptocurrency or blockchain, may have taxable income if the distributed currency
has value.
Payments in virtual currency are also subject to backup withholding if a cash payment of
the same amount would also be subject to backup withholding.
Payments to independent contractors in cryptocurrency worth $600 or more must be reported to the
IRS and to the recipient on Form 1099–MISC, Miscellaneous Income.
Considering the resources required, cryptocurrency mining is considered a business and income
received for mining coins is considered ordinary income.
If the taxpayer is not an employee of the mining company, then they will be subject
to self-employment taxes as well as ordinary taxes on the income.
To determine gain, if a particular cryptocurrency was received at different prices, then any
cryptocurrency sold or otherwise disposed of, must be identified to determine the basis
and the resulting gain or loss.
If the units are not identified, then the disposition is considered to be first-in,
first-out (FIFO).
Capital gains and losses involving cryptocurrencies are reported the same way other capital gains
or losses are reported on Form 8949, and then summarized on Schedule D, as you can see with
this example.
The results are then transferred to Form 1040, U.S. Individual Tax Return.
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