Too often in conversation have I heard false statements like “cryptocurrency is only taxable when you convert to cash.” As part of the process of becoming a legitimate and accepted asset class, governments are becoming increasingly involved. It is important to understand tax that may be applicable to your Cryptocurrency. Failure to report taxable income and capital gains could result in serious consequences.
While we are not qualified to provide financial or tax advice, this article will provide a summary of cryptocurrency tax in the United States as we understand it. If you are looking for tax advice, we recommend contacting a qualified tax advisor or reading the Internal Revenue Service’s (IRS) page Frequently Asked Questions on Virtual Currency Transactions and their 2014 publication on crypto-assets IRS Notice 2014-21, where we have sourced our information.
The IRS classifies cryptocurrencies as property for tax purposes. Treating the whole asset class as property simplifies treatment in many regards. Under these tax rules, there are two scenarios in which you should consider tax. When you receive cryptocurrency and when you dispose of cryptocurrency.
While there is no tax when you buy cryptocurrency, if you receive cryptocurrency through other means, whether through income, interest, airdrops, mining, staking, or any other type of rewards, this will need to be included under ordinary income using fair market value at the date received.
Example: If you receive $10 USD worth of bitcoin as a reward for signing up for an exchange this is considered income. If the bitcoin increases in value to $15, you still only need to disclose the $10 as income. Any change in value will not be taxable until you dispose of the cryptocurrency. These same rules apply for the cryptocurrency you may receive from staking, mining, or other forms of rewards and income.
Suppose you receive virtual currency that can be classified as a bona fide gift. You do not need to recognize the value as income. There is no tax applicable until disposing of the currency, at which point the full amount is taxable, has cost you nothing to acquire.
With cryptocurrency values on the rise, the biggest taxable event is likely to be when you dispose of your tokens. Like property, increases and decreases in the value of your cryptocurrency will be treated as capital gains and capital losses at the time of disposal.
A disposal is not necessarily a sale for cash. If you exchange one cryptocurrency for another, buy goods or services with your cryptocurrency, or even gift it to someone else, these are all considered disposals for tax purposes, and capital gains tax rules will apply.
If you dispose of a cryptocurrency for more than you paid for it (measured in USD), you will pay capital gains tax on the difference. If you dispose of a cryptocurrency for less than you paid for it, this is considered a capital loss. You can use capital losses to reduce your capital gains. Capital gains tax is calculated on your net capital gains or losses, or capital gains minus capital losses. If you have a net capital loss, you cannot use this to reduce ordinary income; however, you can carry it forward to future years.
Cryptocurrency you receive as income or as a reward is treated under ordinary income rules at the date received. Only the increase or decrease in value after that date is used to calculate capital gains or losses.
Example: Let’s assume you purchased $10 worth of Bitcoin that grows in value to $15. You then trade your Bitcoin for $15 worth of Ripple which subsequently decreases in value to only $5. You have yet to dispose of your Ripple. In this example, you had a capital gain of $5 on your Bitcoin, Which is taxable. The change in value on your ripple is not considered because you have not disposed of it yet. Now let’s assume instead that you sell your ripple, you will now have a tax loss of $10 on your Ripple. This can be used to net out your $5 capital gain. In this example, You will not pay any tax on your $5 capital gain and instead carry forward a capital loss of $5 ($5-$10), which can reduce capital gains in future years.
The IRS does specify specific tax rules for businesses who buy and sell cryptocurrency and who may treat these assets like inventory. Similarly, mining cryptocurrency may be considered a business in certain circumstances and be eligible for business deductions. For more information on businesses and cryptocurrency, we recommend referring directly to IRS Notice 2014-21 or contact a qualified tax advisor.