Today’s average cryptocurrency investors, which number in the hundreds of thousands, may not even be aware that they need to pay taxes on their cryptocurrencies. But there is no longer any reasonable doubt regarding the need for reporting capital gains, compliance, auditing, accounting and taxation to the tax authorities. As of October 9, 2019, the IRS has issued official legal guidance on cryptocurrency taxation for the second time in five years.
There is a growing list of cryptocurrency businesses and blockchain operations that transact and operate in cryptocurrencies — and they already know about the best tools to help them. As a result, many of their users and clients must also transact through similar means. The ease of purchasing and entering the cryptocurrency ecosystem is also improving, and more people are participating every day.
However, unlike blockchain-based businesses, the average investor is unsure of what cryptocurrency events are considered “taxable” and which are not. For the prudent investor interested in understanding the full picture of cryptocurrency finances, it is imperative to understand taxable events for cryptocurrencies. The push of this digital asset class into the mainstream world is moving at blinding speeds and staying informed is a key ingredient for investors’ and a business’s success.
Below is a list of the most important taxable events for cryptocurrency investors and businesses.
Taxable Cryptocurrency Events
Buying or Transacting in Cryptocurrency
Any time someone makes a purchase using cryptocurrency — for example, purchasing concert tickets — it is considered a taxable event. Additionally, any type of cryptocurrency transaction in exchange for goods or services will trigger a taxable event in the eyes of the tax authorities. Any type of buying, selling, trading and transacting with cryptocurrencies are considered taxable events. Additionally, purchasing one type of cryptocurrency for another, such as buying ether with bitcoin, is also taxable.
HODLing Your Cryptocurrencies
For those who do not know what HODLing is, it is an unofficial cryptocurrency industry term for those that hold onto their cryptocurrency for long periods of time. Because cryptocurrencies are regarded as property, the IRS considers HODLing cryptocurrency for over one year as a taxable event. That means investors choosing to sit on their assets for over 365 days will be liable to pay capital gains on their assets as a long-term investment.
While businesses and individuals face several distinct differences when it comes to cryptocurrency taxes, all types of mining operations will trigger taxable events. For example, if a person sets up a cryptocurrency mining rig in their home, they are required to track their profit and loss of every cryptocurrency they mine. Businesses and individuals are both required to monitor and report every transaction that has occured and reference the original price of assets at the time they were mined and/or sold.
Based on the new IRS stance on cryptocurrency mining, the constant volume of transactions almost always creates a taxable event, unless coins are “transferred,” which is now considered a nontaxable event.
Converting Cryptocurrency Into Fiat
For investors or users seeking to convert their cryptocurrency earnings into fiat, for any reason, they are required to pay taxes on that activity. This is why it is important to have the best tools to monitor and record all transactions to streamline the accounting and taxation process come tax season in 2020.
Blockchain Forks and Airdrops
Even though the procurement of cryptocurrencies via blockchain forks and airdrops is not entirely the choice of the holder, the fact that they received an asset with a noted value means every fork and airdrop needs to be accounted for.
The new IRS guidance for cryptocurrency forks and airdrops means that any cryptocurrency owned or received via hard fork or airdrop, regardless of consent, are the result of taxable events. The amount of tax owed per asset is determined by the amount spent to acquire it.
Receiving a Crypto Salary
For many cryptocurrency businesses and operations, it’s becoming increasingly popular to pay out employee salaries in fiat, using their personal cryptocurrency funds. While this practice is still gaining interest, there are issues such as opening bank accounts, high volatility and more. But ultimately, employees or freelancers receiving payment in cryptocurrency must report their earnings as this is classified as a taxable event.
Nontaxable Cryptocurrency Events
Purchasing Cryptocurrency With Fiat
While buying an item or service with cryptocurrency and converting to fiat currency remain taxable, the act of first buying your cryptocurrencies via fiat is not a taxable event. Because cryptocurrency is considered property, as stated by the IRS, it is subject to the same rules of capital gains tax. For example, when an investor HODLs an investment for over one year, similarly to property, the investor is taxed according to their respective individual tax bracket.
Donations and Gifts in Cryptocurrency
For generous investors or nonprofit organizations that receive cryptocurrency, these events are not regarded as taxable. Any gift in the form of cryptocurrency that is sent to another individual or a nonprofit organization is not deemed a taxable event.
It may be more clear to most that there are far more taxable events than nontaxable events in the world of cryptocurrency. Most events and transactions that occur are indeed taxable. However, it is important for investors to know that when they send cryptocurrency from one personal wallet to another, or from one personal exchange account to a different personal wallet, that is regarded as an internal transaction, and, therefore, it is not a taxable event.
Defunct Cryptocurrency Wallets and Exchange Shutdowns
Should the unfortunate scenario unfold where your preferred cryptocurrency exchange or wallet is no longer active and available, it is important to be proactive and prudent. Investors are solely responsible for keeping a copy of all of their accounts and transactions from their third-party cryptocurrency vendors, such as an exchange.
According to the IRS, investors remain liable as they had the capability of originally recording the transactions they may no longer have access to. But if a service provider, such as an exchange, can no longer provide the necessary information, the chances of leniency from the tax authorities is much higher.
Additionally, it is always important to show good faith and make an attempt to rectify the situation, rather then put a “0” in your capital gains section of your schedule-D IRS form.
Taxation by Asset Class
The method of classifying taxation by asset class has been made more clear since the latest IRS guidance was released. The value of cryptocurrency purchased in an exchange is determined by the amount that the exchange sold it for in U.S. dollars. This will include commissions, fees and other purchase costs. Additionally, when it comes to calculating income cost basis, the preferred method is “First In, First Out” for the calculation of cryptocurrency profits and losses.
Now, What’s Next?
Now that you have a clearer picture of which cryptocurrency actions are taxable, you may be ready to learn how to prepare your cryptocurrency taxes on your own. But, if you are a high net worth investor, represent a cryptocurrency business or if you would prefer to outsource your cryptocurrency taxes, try looking at some of the top cryptocurrency accounting and tax firms you should know about.
To read the complete document from the IRS on handling tax treatment for cryptocurrencies, please review this IRS Q&A. If you’re interested in learning more about Blox, cryptocurrency accounting or cryptocurrency taxes, visit the Blox blog.
This is an op ed by Alon Murdoch. Opinions expressed are his own and do not necessarily reflect those of Bitcoin Magazine or BTC Inc. This article is for information purposes only and does not constitute legal or tax advice. Always perform your own due diligence and consult with legal or tax professionals.
Alon Muroch is the CEO and co-founder of Blox, an industry-leading platform that provides tracking, management and accounting solutions for professionals and businesses, with more than $3 billion in digital assets managed.