At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?
This is the first question the IRS asks after entering your name and address on your tax return. Although the rules surrounding cryptocurrency (crypto) are evolving, you don't want to lie on your tax return. It's a felony and may even result in jail time, so check "Yes" if you did, and report your taxable transactions.
What Are Taxable Cryptocurrency Transactions?
There are 3 ways to trigger an IRS taxable event:
You sell crypto for USD
You trade 1 coin for another coin (e.g., $20k of BTC turns into $40k of Fair Market Value (FMV) 3 months later. You then buy 20k coins of another crypto with that $40k. You will pay tax on the original $20k gain)
You buy something with a coin (this includes paying employees, property in the metaverse, NFTs, etc.)
The most important thing you can do is track the basis, which is simply the USD value of the cryptocurrency at the time of transaction. When you receive crypto or buy it, record the basis, as tax will be assessed on the amount over or under this when the coin is paid to someone or transferred for something.
How is Cryptocurrency Taxed?
Cryptocurrency is treated as property in the eyes of the IRS. It is similar to capital gains tax on selling stock, business, or real estate. The rate at which it is taxed depends on how long you held the asset.
The basis is important here. When you sell the crypto or pay someone with it, you must calculate your gain or loss on that asset. If it's a loss, you will be able to write it off against other gains. If it is a gain, it is treated as such.
Short-term capital gain: If bought and sold in under one year, it will be taxed at your ordinary income tax rate
Long-term capital gain: If bought and sold in over one year, then the gain is taxed at your capital gains rate of 15% (this becomes 20% once you make over $400k of taxable income)
How this relates to a crypto based business:
When you collect crypto as revenue, it is taxed like ordinary income would be if it were USD paid to you for the service or product you sell
If you mine crypto, you are responsible for tax on the FMV at the time it was mined (in addition to any future capital gains tax)
If you convert USD to crypto to build your asset balance, your basis in that asset is the price you paid. Any gains or losses on that asset will be treated as capital gains
If you pay someone during the course of your business with crypto, you will compare the FMV of the asset on the date of transfer with the basis in that asset to determine the tax implications
If you get scammed with or by crypto, you can write off the loss amount in the same way you would if your restaurant or store got broken into and ransacked
There are several softwares that make coin tracking and tax filing a breeze. Here are my favorites:
All of the above allow you to track initial basis of the coin, track changes in value over time, and will identify the date and value of the coin when you transfer it. Very helpful if you trade cryptocurrency frequently or if you are just getting started and want to stay organized.
Cryptocurrency Wash Sales
A wash sale is the sale of a security (or "stock") at a loss and repurchase of the same or substantially identical security shortly before or after. Losses from such sales are not deductible in most cases under the Internal Revenue Code in the United States.
Not with Cryptocurrency...yet!
For the 2022 tax year, the IRS is treating cryptocurrency as property, not a security, so these wash sale rules do not apply.
What this means for you, is that you are able to sell your cryptocurrency assets at a loss, take that loss on your tax return, and still be able to repurchase the same shares at the lower price.
This allows you to capture a loss on your tax return for the 2022 tax year, but keep in mind that your "basis" in the crypto will now be your new purchase price, not the original purchase price. So, if you are able to sell those same assets for a gain later in life, your gain will now be equal to future sale price minus your re-purchase price. So, considerations to make as you evaluate this strategy.
If you have any questions about cryptocurrency tax implications or need help developing a tax strategy, reach out to our team. We'd love to help!