Cryptocurrency: Tax Implications of Selling, Exchanging, Holding, and Using Virtual Currency
Gains from cryptocurrency are taxed just like gains from any other property. There are tax consequences for selling, exchanging, and holding cryptocurrency as an investment. There are also tax implications of using cryptocurrency to pay for purchases or accepting virtual currency in exchange for goods or services.
If you have not reported cryptocurrency-related transactions correctly on your tax returns, you should try to get into compliance before the IRS contacts you. It's always better to reach out to the IRS proactively — especially if you're worried about potential criminal exposure due to tax fraud or evasion. The IRS recently added cryptocurrency to its Voluntary Disclosure Program.
To help you out, this guide explains the tax implications of cryptocurrency in a variety of different situations. Then, it looks at what to do if you're behind on your reporting obligations.
How to Calculate Gain or Loss on Cryptocurrency
To calculate your gain or loss on cryptocurrency, subtract the basis of the cryptocurrency from its fair market value on the day you dispose of it.
The basis is the fair market value of the crypto the day you received it plus any fees, commissions, or other acquisition costs. For example, if you purchase crypto for $900 and pay a fee of $100, your basis is $1,000. If someone gives you crypto worth $1,000, your basis is also $1,000.
When you dispose of the crypto, subtract the basis from its fair market value on the day of disposition. For instance, say you have crypto with a basis of $1,000 and you cash it out for $1,500 USD, you have a gain of $500. If you have crypto with a $1,000 basis and you sell it for $800, you have a loss of $200.
Short- Versus Long-Term Cryptocurrency Gains and Losses
Long-term capital gains apply when you have owned the cryptocurrency for over a year. If you owned the crypto for less than a year, you incur short-term gains. The holding period starts the day after you acquire the crypto and ends the day you dispose of it.
For example, if you receive virtual currency on Jan 1, 2021, and sell it during 2021, you have a short-term gain or loss. If you dispose of it on or after Jan 2, 2022, you have a long-term gain or loss.
Short and Long-Term Capital Gains Rates on Cryptocurrency
Short-term gains are taxed at the same rate as your income. As of 2022, the rate can be anywhere from 10 to 37%. For most people, the long-term capital gains rate is lower than the short-term rate.
As of 2022, the long-term capital gains rate is 0% if you're single with taxable income between $0 and $41,675, 15% if you're single with income between $41,676 and $459,750, and 20% if your income is over that threshold. The income brackets double for married couples filing jointly.
When Do Capital Gains Apply for Cryptocurrency?
Capital gains don't just apply when you purchase and hold crypto as an investment. They can apply any time you acquire crypto and it grows or shrinks in value.
For instance, if someone gives you crypto as a gift, and by the time you spend it, it has appreciated in value, you have a capital gain. However, if it had decreased in value, you would have a loss that you could use to offset your taxable gains.
Receiving Virtual Currency for Goods or Services
If you receive virtual currency for goods or services, you must report the crypto as income. Use the fair market value of the cryptocurrency on the day you receive it. For example, say that you do web design for someone and they pay you with crypto worth $3,000. You must note $3,000 as income on your tax return.
Because this is business income, you also get to subtract expenses from your income. That rule applies whether you pay for the expenses using U.S. currency, cryptocurrency, or anything else.
To continue with the above example, imagine that while working on this project, you spend $100 USD on supplies but you also use $300 worth of cryptocurrency to buy software. You have $400 of business expenses which you can deduct from your business income.
However, if the crypto you spent changed in value while you owned it, you may have an additional tax consequence as explained below.
Paying for Services With Virtual Currency
When you pay for services with cryptocurrency, your gain or loss is the difference between the fair market value of the services and the adjusted basis of the cryptocurrency.
Here's an example to illustrate this concept. Imagine that Joan receives $500 worth of cryptocurrency on March 1, 2021. On June 2, 2022, she uses all of this crypto to pay an accountant to do her tax return. The fair market value of the accountant's services was $800.
Joan's basis is $500. The fair market value of the services is $800. Her capital gain is $300. Because she had the crypto for more than a year, she has a long-term capital gain, and she needs to report this gain on her tax return.
But now, let's say that Joan was paying the accountant to do her business taxes. Now, she has two tax-related events. She must report the $300 in capital gains, but she can also report the $800 accounting bill as a business expense.
Selling or Exchanging Property for Virtual Currency
If you sell property for crypto, you calculate your gain or loss by subtracting the basis of the property from the fair market value of the crypto. For instance, say you own a building with a basis of $100,000 and you sell it for $150,000 of cryptocurrency, you have a $50,000 gain.
When doing these calculations, you should use the fair market value of the crypto. But in situations where you cannot find the fair market value of the virtual currency, you should use the fair market value of the property.
Crypto, Forks, and Airdrops
A fork is a change to the rules governing the blockchain that created the cryptocurrency. The chain splits at the fork, creating a new set of blockchain with the same history of the original cryptocurrency but moving in a new direction. Here are the tax implications of crypto forks.
Soft Forks Versus Hard Forks
Soft forks add new security features or functions to the crypto but don't create any new currency. As a result, you don't receive any income and you don't have to report anything on your tax return. Hard forks, in contrast, feature drastic code changes that create a new version of cryptocurrency and may come with tax implications as outlined below.
Hard Fork, Airdrop, and New Currency
If you receive new cryptocurrency through an airdrop following a hard fork, you have taxable income. But if a hard fork occurs and you don't receive any new currency, you don't have taxable income. An airdrop is a distribution of cryptocurrency to a taxpayer's ledger address.
You should report ordinary income equal to the fair market value of the crypto the day you received it. If you eventually sell the crypto or use it to buy goods or services, you will need to calculate a gain or loss as explained above. Use the fair market value of the crypto the day you received it as your basis.
Here's an example. Say that you have crypto worth $1000. A hard fork occurs and you receive new crypto worth $200. You must report $200 as ordinary income. A couple of years later, you exchange the crypto received in the airdrop for $500 USD, you now must report a capital gain of $300.
Taxation on Gifts of Cryptocurrency
Gifts are not taxed. But to avoid taxation, the crypto must be given to you as a bonafide gift. For example, if your grandma gives you $1,000 of virtual currency as a birthday present, that is a bonafide gift with no tax consequences.
In contrast, if your boss gives you $1,000 of crypto after you complete a bunch of work and says it's a gift, the IRS isn't likely to see that as a gift. In this case, you have received income and you must report it as such.
Although there are no taxes for receiving gifts, you may face taxes when you sell, exchange, or dispose of the cryptocurrency. At that point, you should use the fair market value of the currency on the day you received it as the basis. Here are a few examples of what happens when you use gifted cryptocurrency.
Tax Implications of Spending Gifted Cryptocurrency
Say that grandma gives you $1,000 of cryptocurrency. A year and a half later, you use the crypto to purchase $1,500 of services. You now have a $500 long-term capital gain. That is the difference between the value of the crypto the day you received it and the value the day you disposed of it.
Tax Implications of Exchanging Gifted Crypto for US Currency
The math is basically the same if you exchange the gifted crypto for US dollars. Imagine that a couple of years after receiving the $1,000 virtual currency gift that you exchanged it for $2,500 USD. Now, you have a gain of $1,500.
But what happens if you turn the crypto into USD the very day that grandma gives it to you? If it hasn't changed in value, you don't have a taxable gain or loss, and by extension, you don't have to report anything on your tax return.
Tax Implications of Regifting Cryptocurrency You Received as a Gift
But what if you decided to give away the crypto? Again, you don't have to pay taxes on bonafide gifts. Say that you give grandma's $1,000 gift of crypto to your favorite nephew when it is worth $1,500.
You don't have a taxable event, and your nephew now has crypto with a basis of $1,500. Note, however, that as of 2022, if you give away more than $16,000 to a single person, you must file a gift tax return.
Tax Rules for Donating Cryptocurrency
When you donate cryptocurrency to a charity, you receive two distinct tax advantages:
- You don't have to report any gains on the crypto.
- You get to claim a charitable deduction on your tax return.
To qualify for this tax treatment, you must donate the crypto to a qualifying charitable organization. You should file Form 8283 (Noncash Charitable Contributions) if your total deduction for charitable donations exceeds $500. Here are details on how to calculate the value of your deduction.
Charitable Deduction for Donating Crypto Held Over a Year
If you have held the crypto for more than a year, your deduction is the fair market value of the crypto on the day you donate it.
For example, say that you purchased crypto two years ago for $1,000. Now it's worth $2,000 and you donate it to a qualifying charity. Your charitable deduction is $2,000.
Although the crypto increased in value, you don't have to report or pay tax on the capital gain.
Charitable Deduction for Donating Crypto Held Over a Year
If you have held the crypto for a year or less, your deduction is the lesser of the basis or the fair market value on the day of the donation. Take a look at these examples.
Imagine that you purchased crypto for $1,000 and six months later, it is worth $1,500. If you donate the crypto to a qualifying charity, your deduction is $1,000 (you use the basis because it's the lowest number).
In this case, it would actually be more financially advantageous to sell the crypto for $1,500 and pay tax on the $500 gain. Then, you can donate $1,000 to charity, claim the $1,000 deduction, and pocket the rest. Or, you can give all of the proceeds of the sale to the charity and take the corresponding deduction.
If the crypto fell in value and you donated it after holding it less than a year, the situation would be a little different. Say that you purchased crypto for $1,000 and six months later it was only worth $500. If you donate this crypto to charity, you can only claim a $500 deduction.
In this case, you might be better off selling the crypto at a loss and using the loss to offset other gains on your tax return. If you like, you can still donate the $500 to charity once you've converted the crypto to cash.
Reporting Cryptocurrency Received as Charitable Contributions
Charities should report virtual currency contributions on Form 990 (Return of Organization Exempt From Income Tax) or Form 990-EZ (Short Form Return of Organization Exempt from Income Tax). Simply note the fair market value of the contribution along with your other contributions on line nine or line one of your respective return.
If your charity sells, exchanges, or disposes of the virtual currency within three years after receiving it, you also need to file Form 8282 (Donee Information Return). You don't have to file this form if the donor signed Form 8283 to indicate that the donation was worth less than $500.
Where to Report Cryptocurrency on Your Tax Return
By now, you have a sense of when crypto creates reportable income or capital gains, but you may still be wondering where to report cryptocurrency gains or losses on your tax return. Here is where you should report cryptocurrency based on the details of the transaction.
- Crypto received as income but not for your business — Schedule 1 (Form 1040) (Additional Income and Adjustments to Income)
- Crypto received as revenue in your business — Schedule C (Form 1040) (Profit or Loss From Business)
- Crypto received as revenue for your farm/ranch business — Schedule F (Form 1040) (Profit or Loss From Farming)
- Crypto received as revenue for your partnership — Form 1065 (US Return of Partnership Income)
- Crypto received as revenue for your S-corp — Form 1120-S (U.S. Income Tax Return for an S-Corp)
- Crypto received as revenue for your C-corporation — Form 1120 (U.S. Corporation Income Tax Return)
- Crypto purchased, held, and sold as an investment — Form 8949 (Sales and Other Dispositions of Capital Assets)
- Crypto received for any reason that created a gain or loss when you disposed of it — Form 8949 (Sales and Other Dispositions of Capital Assets)
These are the most common places to report cryptocurrency on your tax return. But depending on the details of the transaction, you may need to report crypto in another spot. Consult with a tax professional if you need guidance.
Cryptocurrency Question on Individual Tax Return
On Form 1040 (U.S. Individual Income Tax Return) there is a question that asks if you have received, sold, sent, exchanged, or acquired cryptocurrency during the year. You should answer yes to this question if you received cryptocurrency that is considered income, or if you disposed of cryptocurrency that created a gain or loss.
However, if you just purchased cryptocurrency but you haven't had any other transactions, you can answer no to this question. Note that if you transfer crypto between your own accounts, that is a non-taxable event. Even if the exchange or platform sent you a tax document detailing the event, it's still not taxable.
Crypto Assets and FBAR Reporting
If you have an aggregate balance of over $10,000 in foreign bank accounts, you must file a Report of Foreign Bank and Financial Accounts (FBAR). Here is an overview of the FBAR requirements so you can see if this rule affects you.
At the time of writing, you are not required to include foreign accounts that only hold crypto assets on your FBAR. However, in early 2021, the Financial Crimes Enforcement Network (FinCEN) released a notice saying that it intends to request an update to the Bank Secrecy Act (BSA) which would require taxpayers to report these accounts.
Be aware that the rules around cryptocurrency and FBAR are likely to change. Contact an accountant or other tax professional for guidance.
What If You Forgot to Report Cryptocurrency Transactions on Your Tax Return?
As you can see, almost every crypto-related transaction has tax consequences. If you failed to report income or capital gains from crypto on your tax return, you underreported your income, and you may have a past-due tax liability.
If the IRS finds out that you have income or gains from cryptocurrency, the agency can send you an assessment and a demand for payment. Plus, the IRS can add penalties and fees for underreporting your income. If you ignore the notices, the IRS can enforce collection actions such as issuing federal tax liens or seizing your assets.
The IRS may also assess civil penalties if the agency believes that you have committed tax fraud or evasion. In extreme situations, the agency can bring criminal charges against people for tax crimes.
If you have unreported crypto losses, you may have missed out on valuable deductions and may have paid more income tax than you should have. In this situation, you may want to amend your returns to reclaim your overpaid tax liability.
How to Deal With Unreported Cryptocurrency Transactions
There are a few different ways that you can address unreported cryptocurrency. Here are the main options based on your situation:
- If you didn't file a return at all — File a delinquent return to report the income or gains from your cryptocurrency. Then, pay the tax owed plus failure-to-file penalties.
- If you filed but forgot to report the crypto — File an amended return to report the crypto-related transactions.
- If you are worried about criminal prosecution — use the Voluntary Disclosure Program.
Consider consulting with a tax professional to ensure you choose the optimal option for your situation.
Cryptocurrency and the IRS Voluntary Disclosure Program
You can only use the voluntary disclosure program if the IRS has not already contacted you about the unpaid tax. If you're already under audit or investigation, you cannot use this program.
To apply for the voluntary disclosure program, start by filling out Part I of Form 14457 (Voluntary Disclosure Practice Preclearance Request and Application). If the IRS grants you pre-approval, you will need to fill out Part II of Form 14457. You can download this form from the link on the IRS's website.
To make a voluntary disclosure, you will need the following:
- Details about all virtual currency transactions for the last six years.
- Information about where the crypto is stored.
- Whether or not you used a mixer or tumbler.
- Why you used a mixer or tumbler.
- Additional details as requested by the examiner assigned to your case.
You will also need to pay all taxes for the last six years and pay a civil fraud penalty of 75% of the highest year's tax liability. If you cannot afford to pay the tax liability in full, you can request a payment plan, but you should be prepared to make a full financial disclosure to the IRS.
In most cases, if you fully adhere to all of the requirements of the voluntary disclosure program, the IRS will not pursue criminal action against you.
Get Help With Cryptocurrency and Taxes
If you have questions about how to report cryptocurrency on your tax return, if you haven't reported cryptocurrency correctly on your tax return, or if you have other issues related to crypto and taxes, you should reach out to a tax professional.
Certified public accountants, enrolled agents, and tax attorneys can help you. Use TaxCure to find a local tax professional experienced with cryptocurrency issues today.
