Recently the prevalence and acceptance of virtual currencies has expanded dramatically. With buying and trading being simplified through trading on the Robinhood and Coinbase platforms, many people have added exposure to this asset class to their portfolios. At the same time the IRS has greatly increased its scrutiny of transactions in virtual currencies and has dedicated significant resources to enforcing the taxation of this asset class. As such, investors and users of these assets need to understand the tax results of transactions in these currencies.
Buying Virtual Currency
When you buy a virtual currency, your basis in the asset is the amount you pay for it. Buying virtual currency is essentially the only transaction with virtual currency that doesn’t create a reportable tax transaction.
Selling Virtual Currency
When you sell virtual currency you must report a gain or loss equal to the difference between your basis and the amount you received on the sale. This gain or loss is treated as a capital gain, subject to preferential rates on gains if held for over a year. Individuals are limited to a deduction of $3,000 for net capital losses, any excess is carried forward to future tax years to offset future capital gains.
The name virtual currency implies that the asset will be used as a currency to buy goods and services like traditional currencies. However, unlike when making purchasing with traditional currencies, purchases with virtual currencies are treated as a sale of the asset for the value of the good or service purchased. As such any purchase with a virtual currency will create a capital gain or loss.
Exchanging Virtual Currency
Exchanging one virtual currency for another also triggers a capital gain or loss. The value of the currency received is compared to the basis in the virtual currency surrendered in the transaction in calculating the reportable gain or loss.
Hard Forks / Air Drops
When a virtual currency undergoes a hard fork, a holder of a virtual currency may receive units in a new virtual currency. This hard fork results in ordinary income equal to the value of the new virtual currency received. The holder’s basis in the currency is the amount of income recognized. Similarly, if you receive virtual currency due to an airdrop you must recognize income equal to the FMV of what was received at the time it was received.
Crypto mining will be discussed further in our business taxation of virtual currency, but as above, if you received it, and didn’t pay for it, you will recognize taxable income.
The IRS is heavily scrutinizing virtual currency, and the tax reporting of these transactions can be voluminous and time consuming. Please, reach out to us early to make us aware if you have transactions in virtual currency.