Please note: The following information is for the US tax system. However, Accounting also provides complete crypto tax services for other countries including the UK, Germany, Australia, Switzerland, and Austria, and is fully compliant with the tax agencies in those countries.
As cryptocurrency becomes increasingly common, the IRS is recognizing it as 'property' and formulating tax laws and regulations. Knowing these laws is essential to ensure accurate calculation of tax liabilities.
IRS Publication 551, known as the Basis of Assets, talks about the value of the taxpayer's investments to evaluate their tax liability. This amount or value is what is known as the basis. Cryptocurrency is classified as a property by the IRS and not as a currency or security. Thus, the regulations and laws laid as part of the Basis of Assets apply to all cryptocurrencies like Bitcoin, Ethereum, etc.
The taxable cost of a property is its basis. For a cryptocurrency (referred to as virtual currency by the IRS) the cost basis is the amount in US Dollars spent for its acquisition.
This cost basis also includes commissions, fees, and any other costs that may be included in the acquisition of the virtual currency. As per Publication 551, the following costs can be included while calculating the basis:
A lot of these may not apply to a cryptocurrency, since Publication 551 deals with all types of property and not just cryptocurrencies.
The cost basis for a cryptocurrency would be the amount paid for its acquisition. This is generally equal to the fair market value of the virtual currency when acquired, at a specific date-time. The time and fair market value of the cryptocurrency on the day it was credited to the taxpayer's account must be recorded.
If the value increases or decreases when the cryptocurrency is sold for cash or exchanged for another virtual currency, there may be additional liability in capital gains/losses. This, again, depends on how it was acquired and the duration for which it was held. The framework is defined in Publication 544 of the IRS.
Sales And Other Dispositions Of Assets-Publication 544
As the name suggests, Publication 544 (Sales and Other Dispositions of Assets) talks about what happens when any property, including a cryptocurrency, is disposed of. For a cryptocurrency, the specific events that are relevant for Publication 544 include:
There are 4 things that are relevant for determining the tax basis, which are:
This has already been covered in detail in the earlier section- the difference in the Fair Market Value on the day of acquisition and disposal is the gain (if the value increased) or loss (if the value decreased).
If the cryptocurrency is held for one year or less before exchanging or selling it, it is a short- term capital gain or loss. Otherwise, it falls under long-term capital gains.
The holding period starts from the day the cryptocurrency gets credited into the taxpayer's account, i.e. the day from which they have control to dispose of it (exchange, sell, or use for a purchasing a service/product). This holding period ends the day it is sold/exchanged.
This part deals with cases where the business property is disposed of. (sold/exchanged) Any gains or losses that are made in such transactions are not part of the business schedule in the tax return. Any losses in such scenarios are fully deductible in the year when the sale was made. Gains are considered as ordinary income and additional gain is treated as short- or long-term capital gain depending on the holding period.
IRS Form 8949-D, used for reporting the disposal and sale of capital assets, is where all details of cryptocurrency transactions are to be filled.
Documents: Form 8949
Once the capital gain and loss on all cryptocurrency (or virtual currency) transactions are calculated, Form 8949 (Sales and Dispositions of Capital Assets) is where they are reported. Every transaction involving crypto assets that were made in the reporting year must be included in this form.
The initial information at the top of the form is the first thing to be filled. After that, the taxpayer needs to select either of the 3 checkboxes in Part I of Short-Term Trades. The options being:
is opted by most taxpayers, as crypto-exchanges do not furnish 1099-B. The following information must be provided about each transaction:
Description/ type of asset- Date of acquisition and selling/disposal- Proceeds (selling value)- Cost Basis- Adjustment to gain or loss- Gain or Loss
Both unrealized and realized cryptocurrency gains (as well as losses) have different tax implications. To realize the difference between them, it is important to understand that any capital gain or loss can only be counted towards tax once it is realized. Even if the taxpayer owns a crypto asset that is showing a loss, it cannot be claimed unless the asset is sold.
Any gains on cryptocurrency are not considered as 'realized' until it is sold, exchanged it, or spent. However, claiming realized losses as capital losses can offset other capital gains and help minimize taxable income.
On the other hand, if the taxpayer has bought the cryptocurrency once and not sold or exchanged it then there is a case of 'unrealized' capital gains or losses. And, because the gain or loss is not realized, there is no need to claim it as a profit or loss. This allows one to hold onto cryptocurrency and potentially defer the associated taxable income.
Multiple and Single Depot transaction methods are simply different ways of representing cryptocurrency transactions to calculate gains or losses enabling tax calculations.
The multiple depot calculation methods take into consideration all exchanges as well as wallets as separate depots. Therefore, the short-term gain or loss calculations are based on individual transactions pertaining to that specific cryptocurrency silo.
On the other hand, a single depot calculation considers all different trades as one large virtual depot for tax estimation purposes. In other words, the short-term gain or loss is calculated based on all trades of the cryptocurrency in one large virtual depot.
Like any other property, the tax rate on cryptocurrencies depends on the holding period, as mentioned earlier. For holding periods equal to or under a year, this tax rate and calculation are the same as ordinary income, and the tax rates are summarized here.
Different cryptocurrencies have risen in popularity in the recent few years. And this fame has urged governments to take notice and regulate this new stream of revenue. In other words, the IRS (Internal Revenue Service) has released guidelines on cryptocurrency tax calculations for investors.
Cryptocurrency tax calculations can often seem confusing, particularly for those who are new to this trading platform. However, if the income generated is not reported properly, it can invoke penalties and even criminal prosecution. Here’s the break down the crypto tax implications for those filing the crypto taxes in the U.S.
Since 2019, the costing methods for calculating cryptocurrency-related capital gains have become explicitly clear. Prior to this FIFO, or the 'First in, first out', calculation method was used extensively by traders for determining their tax liability. Today, LIFO (Last in, first out) and HIFO (Highest in, First Out) can also be used for calculation purposes. This is good news for cryptocurrency traders as it allows them to benefit from opportunities for tax savings.
The following three calculation methods use different ways to calculate this cost price of the currency:
FIFO - First In, First Out
As the name suggests, this method of calculation takes into consideration the first cryptocurrency coin that is purchased as the first item that is considered for a sale.
Using the FIFO method, capital gains will be calculated as per the price of the 1st 10 units that were bought on 10th February 2017, i.e. $400 per unit or $2000 for all.
So, FIFO calculation will be as follows,
In other words, the coins are sold in the same chronology as they were purchased, hence, 'First in, First out.'
In complete contrast, the LIFO method takes into consideration the last units purchased as being the first ones for sale. So, the calculation of capital gains and selling price will be done on the last 5 BTC purchased. The calculation will be as follows,
This method uses the coins with the highest purchase price as the one sold first. So, the calculation will be as follows,
The HIFO method is ideal for minimizing tax as it is designed to calculate the largest capital losses as well as the lowest capital gains providing the tax calculator the best case in both the scenarios. While here the HIFO is displaying the same capital gain figure as LIFO, it changes as volumes increase.
Out of the methods of calculation, HIFO and LIFO can help the taxpayer arrive at a lower amount of capital gains on which crypto tax may be owed. On the other hand, FIFO is a great method for tax-loss harvesting as it helps generate the most amount of losses.
In short, they protect one from paying short term capital gains rate as they extend the overall holding period of the Cryptocurrency. Also, capital losses generated from the sale of cryptocurrencies are allowed to be deducted against any other capital gains as well, even if these gains are not from cryptocurrency.
While both methods have their own advantages and disadvantages, the benefits depend on the volume, rate, purchase, as well as the sale price of transactions being considered for a specific taxation period.
Bitcoins, or any cryptocurrency, received as a payment from providing some service or product are treated as ordinary income. The federal tax on this income can range anywhere between 10% to 37% depending on the taxpayer's income slab. Additional state taxes depend on the taxpayer's local state laws.
For instance, if 2 bitcoins are received in an exchange for certain services, then the following points would help in understanding how they would be taxed:
The IRS clarified that income received in exchange for a product or service is taxable- regardless of whether they are provided as an employee of a company or as an independent contractor.
There may be cases where the cryptocurrency received in exchange for a product or service does not have a published value. In such a scenario, the fair market value of the service or property exchanged for the cryptocurrency would be considered as the cryptocurrency's fair market value. This is to be recorded at the time when the transaction occurs.
A hard fork is related to blockchain technology in general, and not just bitcoins. It refers to a major change in the network protocol, which renders all earlier invalid transactions and blocks valid or vice versa. In the case of a hard fork, all users/nodes in the blockchain must upgrade to the protocol software's latest version.
A few reasons why forks happen are:
Cryptocurrency forks are part of the IRS's 2019-24 ruling and guidance. If a cryptocurrency held by the taxpayer has a hard fork, then any new forked currency received would be taxed as income . The cost basis of this new cryptocurrency is the recognized income for calculating tax.
For instance, consider a holding of 2.5 bitcoin in June 2017. As a result of the hard fork, the holder of 2.5 bitcoins would have acquired an additional 2.5 Bitcoin Cash. This new 2.5 Bitcoin Cash would have to be recognized as income based on the Fair Market Value on the day it was received. If the Bitcoin Cash price was
$500 on that day, the total ordinary income to recognize would be 2.5 * $500= $1,250.
Another similar term is a cryptocurrency soft fork. In a soft fork, a change in the protocol renders only previously valid transactions/blocks as valid. No new cryptocurrency is created as part of a soft fork, so no tax liabilities are there.
An Airdrop refers to the distribution of a cryptocurrency coin or token. This is generally done for free and involves credit to many wallet addresses. A cryptocurrency airdrop aims to gain new followers and attention. The large-scale disbursement of coins helps to attract a large user base. Airdrops distribute cryptocurrencies either by selecting the recipient wallets at random or by publishing about the event in a related newsletter or bulletin boards.
As per the IRS guidelines, an airdropped cryptocurrency will produce a receipt when it gets recorded on the new ledger. For tax purposes, the receipt may take place earlier or later, depending on when the taxpayer can exercise control of the new cryptocurrency.
For instance, the airdropped cryptocurrency may not credit the holder's account at the crypto exchange immediately. This may be because the exchange does not support that specific cryptocurrency yet. In such a case, the IRS will consider the date of receiving the cryptocurrency later- once it gets credited into the taxpayer's account and they can sell, transfer, exchange or dispose of it otherwise.
There can be multiple scenarios of airdropped and hard forked cryptocurrencies. With the IRS still formulating rules around the same, not every scenario may have a defined rule for it. Two of the most common scenarios on how the tax would be calculated are discussed ahead.
If a cryptocurrency goes through a hard fork, it creates new cryptocurrency. However- the units/coins of this new cryptocurrency are not transferred into an account that the taxpayer can control. Since no units/coins yet are credited, there is no gross income at that time on which federal tax is to be paid.
Similar to the above example, suppose that units of this new cryptocurrency are airdropped in the taxpayer's ledger address and are immediately available for disposal. In such a scenario, the recipient has what IRS terms as 'accession to wealth' and ordinary income in the ongoing tax year. This ordinary income equals the fair market value of the new units at the date-time when the airdrop transaction gets recorded on the blockchain ledger.
Cryptocurrency received in any form including from forks, mining, airdrops, lending, etc. will be treated as regular income and must reflect as such in income tax calculations. However, it is essential to remember that cryptocurrency is considered as property for tax calculation purposes. And any sale of this cryptocurrency will attract a capital gains tax depending on the duration for which the cryptocurrency was held. Therefore, the best method to minimize crypto tax is to buy and hold cryptocurrency for more than a 12-month period.
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