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It is hard to argue with the fact that cryptocurrencies have gone mainstream the last few years. While different versions and concepts for a digital currency go back decades, the modern movement generally started with bitcoin in 2008. Today there are hundreds of different types of digital assets (either digital tokens or cryptocurrencies) that are available on varies marketplaces, although only a handful have mass adoption and value. Of those, bitcoin is still the most well-known and widely owned. Bitcoin reached new publicity in 2013 when it was first seized by a government entity, ruled as a form of currency by a Federal Judge, and online retailer Overstock.com announced it would accept it as payment. Finally, in 2017 with the price of one bitcoin running from around $930 to $20,000 by the end of the year, it became simultaneously an example of wild financial speculation and a life altering path to wealth.

Despite the manic price swings and unknowable potential, cryptocurrencies continue to be popular with some investors, many speculators, and the curious who just want to join in. Regardless which camp you fall into, if you are going to ever buy or sell cryptocurrencies you need to know how the tax implications.

How is cryptocurrency reported

Up until this point transactions in cryptocurrencies are mostly self-reported, but please don’t assume that no one is paying attention. The 2020 Form 1040 (individual tax return) the IRS released contains the following language on the first page, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”. The fact that it is featured prominently on the first page of your tax return should give you a clue that it is being closely monitored. Most people buying or selling are doing so through one of the large online platforms such as Coinbase, which just went public early this year. Currently they don’t provide consumers with an itemized 1099 at the end of the year like brokerage firms do. That means it is up to the individual to track all transactions as well as their cost basis in any cryptocurrency transactions. There is speculation that the records of these online platforms, especially as they seek to go public, will eventually be opened to the IRS to analyze. Anyone who previously tried to hide gains from trading might be in for a rude awakening in the coming years if more carful oversight evolves.

How is cryptocurrency classified?

The funny thing about cryptocurrencies is that there is still a bit of confusion over what to classify them as. Take bitcoin for example. Is it a currency like the dollar, an investment like a stock, a commodity like gold, an intangible asset, or something else entirely? Without uniform global standards for this, here are a few of the ways bitcoin is currently viewed.

As you can see the future is uncertain until these organizations start to come together to create some kind of uniform policies and procedures. How it is ultimately defined will determine how it is taxed in the future, but currently we must follow the rules as laid out by the IRS.

How is cryptocurrency taxed?

The IRS’s current position on cryptocurrency is that it is property, so it is subject to reporting of gains and losses when sold or exchanged. That means that even if you swap one cryptocurrency for another it is considered a transaction that is reportable and taxable.

Cryptocurrencies, like other capital assets, are subject to short-term or long-term capital gains depending on the length of time you hold them. Selling for a profit before the one year holding requirement generates a short-term capital gain while anything beyond one year receives preferential long-term capital gain treatment.

One very notable difference between cryptocurrencies and most other capital assets is they are not subject to wash sale rules.  Wash sale rules prevent the tax deduction of otherwise allowable loses when a taxpayer repurchases a substantially identical security within 30 days of the previous sale. In other words, if you sell your Amazon stock for a $1,000 loss, then rebuy the stock within 30 days, you can’t claim that $1,000 loss on your taxes. With cryptocurrencies you can.

Planning ahead for taxes and cryptocurrencies

If you are going to buy or sell any cryptocurrencies here would be a few ideas to make it easy on yourself, or your CPA, come tax time.

  • Record all the details of your transactions. Many online platforms, like Coinbase, will give you a confirmation that includes the date, how much you invested, amount of cryptocurrency you purchased, price per unit, and any transaction fees. Print that out and save it with your other tax info.
  • Make sure you are reporting purchases, sales, and exchanges using cryptocurrencies.
  • Keep a central database of the details if you have frequent transactions so you can use the specific identification method to sell specific lots (amounts purchased together) to maximize tax-deductible losses when you want to.

The last, but most important, point related to cryptocurrencies and taxes is to stay up to date. All these rules are shifting as government regulators learn more, especially as the use cases for cryptocurrencies evolve. Like the movement of their price, the rules around the taxation of cryptocurrency could change at any moment.