Our tax compliance practice helps clients to correctly report cryptocurrency assets on the current year’s tax return, file amended returns for prior years, and remain compliant with the IRS. According to the IRS, if a U.S. taxpayer does not accurately report his virtual currency transactions, he may be subject to future civil and criminal enforcement activity.
Individuals who have been engaged in cryptocurrency trading within US and non-US exchanges may be subject to new IRS compliance efforts. In fact, the IRS has collected 10,000+ names of American taxpayers who own digital currencies, many of whom will receive letters stating that previous tax-year transactions were incorrectly reported.
As IRS Commissioner Chuck Rettig explained, “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest, and penalties.”
Individuals who have received one of these letters will have questions about how to comply, especially if some of their transactions occurred on multiple foreign exchanges.
Virtual currency is considered property for federal income tax purposes. Generally, U.S. taxpayers must report all sales, exchanges, and other dispositions of virtual currency. An exchange of a virtual currency (such as Bitcoin, Ether, etc.) includes the use of the virtual currency to pay for goods, services, or other property, including another virtual currency such as exchanging Bitcoin for Ether. This obligation applies regardless of whether the account is held in the U.S. or abroad.
More information can be found on www.irs.gov and in Notice 2014-21 which describes how general tax principles for property transactions apply to transactions involving virtual currency.
Through its Virtual Currency Compliance Campaign, as well as increased use of data analytics, the IRS aims to help taxpayers fully understand their obligations under the US Tax Code. Their guidance for compliance is to follow the “general tax principles applicable to all transactions in property” for the reporting of digital assets. Accordingly, if one purchases Bitcoin and then sells it or swaps it for something else, a capital gain or capital loss will be incurred. Any captured gains must be reported, and taxes must be paid.
Three different versions of the letters were issued to taxpayers: Letter 6173, Letter 6174, and Letter 6174-A. Taxpayers in all three categories are urged by the IRS to file amended or delinquent (late) returns as necessary, depending on their unique situations.
- Letter 6173 – You may have received this letter if you “have or had one or more accounts containing virtual currency and may not have met your U.S. tax filing and reporting requirements for [virtual currency] transactions.”
- Letter 6174 – You may have received this letter if you “have or had one or more accounts containing virtual currency but may not know the requirements for reporting transactions involving virtual currency.”
- Letter 6174-A – You may have received this letter if “have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency.”
Our cryptocurrency and tax compliance practice has experience with tax guidance for numerous holders of cryptocurrency, and we can help determine the most appropriate course of action.
What do individual taxpayers need to know for reporting virtual currency to the IRS in 2020 tax filings?
- Anyone who has sold off some of their crypto assets will need to report that in their 2020 tax return.
- The IRS is asking filers to report on whether they sold, received, sent, exchanged, or otherwise acquired any financial interest in a virtual currency.
- The “Yes” box must be checked even if a taxpayer received crypto for free, exchanged for goods or services, or swapped for other property, including digital assets.
Most major cryptocurrency exchanges will provide taxpayers with a Form 1099-K, but only if their gross payments exceeded $20,000 and they made more than 200 transactions.
People who have traded on multiple exchanges will be more spread out and it will be far more challenging to gather all of this information to calculate gains and losses.
Many tax professionals have complained that a $20,000 threshold is too high, because most taxpayers have either done less than 200 transactions on a single exchange, or they have used multiple exchanges and will not hit this threshold on any of them. However, taxpayers are still required to report these transactions for tax purposes, even when the threshold is not met,
Three crucial factors that taxpayers should know about cryptocurrency:
- What is the fair market value of the virtual currency at the time of the transaction?
- What is the basis, or the amount paid when asset was acquired?
- What was the holding period, or the length of time the asset was held before being sold?
If the holding period was greater than one year, it will be considered a long-term capital gain, and if it is less than one year it will be considered ordinary income.
The difference in tax treatment is quite dramatic. Long-term capital gains are subject to tax rates of 0%, 15%, or 20%, while ordinary income rates can be as high as 37%.
How to prove the fair market value of digital assets to the IRS
If cryptocurrency is received in a peer-to-peer transaction, or another transaction not facilitated by an exchange, the fair market value of the cryptocurrency is determined as of the date and time that the transaction was recorded on the distributed ledger, or when it would have been recorded had it been an on-chain transaction.
As evidence of fair market value, the IRS will accept the “value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates its value at an exact date and time. If an explorer value is not used, the evidence must be provided that establishes the value used is an accurate representation of the virtual asset’s fair market value.
In such cases where the cryptocurrency does not have a published value, an acceptable method of establishing value is to make it equal to the fair market value of the property or services exchanged for the cryptocurrency at the time the transaction was made.
For additional questions about your tax reporting requirements in connection with cryptocurrency transactions, please contact Dilendorf Law Firm by calling us at 212.457.9797 or emailing us at info@dilendorf.com
Additional Resources
- Virtual Currencies | Internal Revenue Service
- IRS Guide to Related Tax Consequences of Buying, Holding and Selling Bitcoin/Cryptocurrency
- Frequently Asked Questions on Virtual Currency Transactions
- Bitcoin and Beyond – Texas Comptroller
- Tax Treatment of Transactions in Cryptocurrency and IRS Tax Enforcement
- IRS Private Letter Ruling on Taxation of Hard Forks and Airdrops
- Understanding the Tax Basics of Virtual Currency
- Virtual Currency: IRS Issues Additional Guidance on Tax Treatment and Reminds Taxpayers of Reporting Obligations
- Publication 525, Taxable and Nontaxable Income, for more information on miscellaneous income from exchanges involving property or services
- Publication 526, Charitable Contributions, for more information on charitable contribution deductions,
- Publication 544, Sales and Other Dispositions of Assets, for more information about capital assets and the character of gain or loss
- Publication 551, Basis of Assets, for more information on computation of basis
- Publication 561, Determining the Value of Donated Property, for more information on the appraisal of donated property worth more than $5,000
- Purchase of US Commercial Real Estate with Cryptocurrencies
