Virtual Currency & Taxes FAQs
Frequently Asked Questions on Virtual Currency, Cryptocurrency, and IRS Tax Rules
Virtual currency continues to build momentum in the public sphere, but what about the tax implications?
Here are some popular FAQs to help you understand how the IRS treats virtual currency, crypto, and other digital currency initiatives.
What Is Virtual Currency?
Virtual currency is a digital representation of value (other than a representation of the U.S. dollar or a foreign currency, a.k.a. “real currency”) that functions as a unit of account, a store of value, and a medium of exchange. The IRS uses the term “virtual currency” to describe the various types of convertible virtual currency – including digital currency and cryptocurrency.
Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A transaction involving cryptocurrency that is recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction.
Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
Note that if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for federal income tax purposes.
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How Does the IRS Tax Virtual Currency?
In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.
For federal tax purposes, virtual currency is treated as property. This means that the general tax principles that apply to property transactions also apply to virtual currency transactions. For more information on the tax treatment of property transactions, see IRS Publication 544 (Sales and Other Dispositions of Assets).
A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. See IRS Publication 525 (Taxable and Nontaxable Income) for more information on miscellaneous income from exchanges involving property or services.
For more information on the tax treatment of virtual currency, see IRS Notice 2014-21.
Do I Have to Tell the IRS If I’ve Owned/Used Virtual Currency?
Form 1040 asks whether, at any time during the year, you received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency. If you purchased virtual currency with real currency (e.g., U.S. dollars) but had no other virtual currency transactions during the year, you are not required to answer “yes” to the Form 1040 question.
What Happens When I Sell or Exchange Virtual Currency?
When you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses. Your gain or loss will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, which you should report on your federal income tax return in U.S. dollars.
[NOTE: The type of gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.]
You must report most sales and other capital transactions and calculate capital gain or loss in accordance with IRS forms and instructions, including on Form 8949 (Sales and Other Dispositions of Capital Assets) and then summarize capital gains and deductible capital losses on Form 1040, Schedule D (Capital Gains and Losses).
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What Happens If I’m Paid in Virtual Currency?
A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. (Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities, and compensation.)
The basis of virtual currency that a taxpayer receives as payment for goods or services is the fair market value of the virtual currency in U.S. dollars as of the date of receipt. See IRS Publication 551 (Basis of Assets) for more information on the computation of basis when property is received for goods or services.
What Records Do I Need to Maintain for Virtual Currency Transactions?
The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns. You should therefore maintain, for example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.
For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.
The definitions and tax rules above are provided by the Internal Revenue Service (IRS). For more information, see the IRS webpage for FAQs on Virtual Currency Transactions.
The IRS continues to adjust its tax guidance as virtual currencies gain more traction, so it’s important to stay up-to-date on the latest tax news.