The Basics
All these cryptocurrency events are taxable and need to be reported on your tax return:
- Selling cryptocurrency for US dollars or other fiat currencies.
- Exchanging one cryptocurrency for another (like exchanging Bitcoin for Ether).
- Buying goods or paying for services with cryptocurrency.
- Cryptocurrency received as a payment for providing goods or services.
- Cryptocurrency received from gambling, gaming, crypto faucets, social media upvotes etc.
- Cryptocurrency received from mining, hard forks and airdrops.
- Cryptocurrency earned from lending programs, stacking, crypto investment programs etc.
- Investing in Initial Coin Offerings (ICOs), Security Token Offerings (STOs) etc.
- Placing cryptocurrency margin trades, hedging, arbitration etc.
- Sending cryptocurrency to someone as a gift and the fair market value (FMV) of the cryptocurrency at the time of gifting exceeds the annual gift exclusion amount.
However, not all cryptocurrency transactions trigger taxation. Following is a list of common cryptocurrency transactions that are not taxable and do not need to be reported at tax time:
- Purchasing cryptocurrency with fiat currency such as USD, EUR etc.
- Transferring cryptocurrency from an exchange/wallet account to another exchange/wallet account.
- Holding cryptocurrency in your exchange or wallet account.
- Receiving cryptocurrency as a gift.
Donating cryptocurrency to a qualified charitable organization is not a taxable event because you don’t need to pay any taxes on it. However, it is a reportable event because you may be able to take a charitable contribution deduction on your tax return.
The Official IRS Guidance
The IRS addressed cryptocurrency for the first time in 2014
In 2014, the IRS issued a series of FAQs that answered some of the questions regarding tax treatment of cryptocurrency activities. This initial guidance established that for tax purposes, cryptocurrency should be treated as property. In other words, cryptocurrency is a capital asset. Any capital gains or losses resulting from cryptocurrency investments should be reported at tax time.
2019’s updated guidance
The IRS issued a new set of FAQs in October 2019. This second round of guidance didn’t change the rules set forth in 2014. However, it did clarify a number of issues and questions about certain unusual situations involving various types of cryptocurrency transactions.
In addition to the new FAQs, the IRS also released Revenue Ruling 2019-24 which addressed airdrops and hard forks. We will discuss more about that in our Airdrops and Hard Forks section later in this article.
New "check the box" question on Form 1040 Schedule 1
Shortly after the new set of FAQs and Rev. Rul. 2019-24, the IRS also released a revised Form 1040 Schedule 1 for tax year 2019. The IRS added a new question to the top of the form, as shown in the screenshot below:
The so-called "check the box" question has drawn immediate attention from tax professionals and crypto taxpayers alike. Many people were caught off guard, and some panicked - especially crypto users who never reported their crypto transactions and tax preparers who had never handled crypto taxes before.
IRS Crypto Tax Reporting Enforcement Efforts
IRS warning letters and tax notices
As part of the Agency’s cryptocurrency tax compliance enforcement efforts, the IRS issued a set of warning letters starting in July 2019 to over 10,000 cryptocurrency owners, advising them to pay back taxes and file amended returns. The set of letters includes IRS letters 6173, 6174, and 6174-A. Some of the letters are educational and some of them have compliance requirements with pretty severe consequences.
In addition, the IRS has been sending CP2000 notices to taxpayers who received Form 1099-Ks from Coinbase, Gemini, Kraken, Uphold and other crypto exchanges. The 1099-Ks reported gross sales proceeds of the account holder’s cryptocurrency sales without any cost basis information.
Many 1099-K recipients did not report or did not know how to correctly report their crypto transactions. As a result, the amount reported on their tax return did not match the amount reported on their 1099-K. These types of discrepancies often lead to a CP2000 notice.
Tax Treatment of Cryptocurrency Transactions
Following is a summary of tax treatment for the most common cryptocurrency transactions:
Trading
In order to find out if you made or lost money on a trade, you need to know your cost basis. The cost basis of your cryptocurrency is the price you paid to acquire your crypto when you bought it. If you received your cryptocurrency as a gift from someone, you need to know the donor’s cost basis in the cryptocurrency, as in most cases that will be your basis as well.
If you have been trading on multiple exchanges, it’s almost impossible for you to calculate your gains and losses manually. The easiest way to do the calculation is with CoinTracking.info. We store historical prices for over 7,000 different cryptocurrencies on our own servers. That helps our software deliver quick, accurate calculations. We also support API and CSV import for almost all exchanges and wallets. Furthermore, we support crypto margin trades, a feature very few crypto tax calculators are offering at this point.
CoinTracking supports 12 different cost basis methods, including FIFO (First In, First Out), LIFO (Last In, Last First Out) and many others. Under the current IRS guidance, there are only two cost basis allocation methods allowed for tax return reporting: First In First Out (FIFO) and Specific Identification method. Once you pick a method, you must apply it consistently. If you have already established a method and you want to change it, you need to apply for an accounting method change first.
In the U.S., you can deduct cryptocurrency losses from your yearly income. The IRS lets cryptocurrency traders write off up to $3,000 in crypto losses from their ordinary income each year. If you lost more than $3,000 in a year, your losses can even be carried forward into future tax years to offset part or all of your capital gains and possibly also some of your ordinary income for up to $3,000. There is no time limit for capital loss to carry forward.
Capital gains and losses from cryptocurrency trades need to be reported on Form 8949 and Form 1040 Schedule D. CoinTracking provides Form 8949 in both CSV and PDF format as part of the tax reports you can generate in your CoinTracking account. Other formats (like TaxAct, TurboTax and Drake, for example) are also available.
Mining
Any cryptocurrency received from mining is considered taxable income. The classification of the income varies depending on the nature of the taxpayer’s activities. Individuals that run cryptocurrency mining businesses are treated differently compared to mining hobbyists and investors.
If you are operating a mining business, you need to report your mining income, measured in USD based on the FMV (Fair Market Value) at the time of receipt of the mined coin, on Form 1040 Schedule C as business income. If you had formed a business entity to do mining, your mining income needs to be reported on your business tax return. Costs related to mining (such as mining equipment and electricity, etc.) are deductible and can be used to offset your mining income.
If you are doing mining as a hobby, such as using your home computer to mine cryptocurrency in the background, any cryptocurrency received from the mining should be reported as hobby income. You may be able to deduct your mining expenses up to the amount of your hobby income.
If you are investing in a mining contract with a third party mining company, the mining income you received should be treated as investment income. Depending on how the mining contract is written, your mining income may be considered interest income or ordinary income. You may be able to treat part of the receipt as a nontaxable return of capital. Alternatively, you can treat the amount you invested in the mining contract as an investment expense. However, under the new tax law, individual taxpayers can no longer deduct any investment expenses.
Airdrops and hard forks
An airdrop occurs when a cryptocurrency is automatically sent out to numerous wallet addresses. A new cryptocurrency is formed when a hard fork occurs, and usually all of the holders of the older coin receive the new coin via airdrops.
According to Rev. Rul. 2019-24, any new cryptocurrency received by airdrop following a hard fork should be treated as ordinary income and reported at tax time. If there was a hard fork but the taxpayer did not receive the new coin, no income needs to be recognized. In other words, a hard fork event itself is not taxable. The receipt of a new coin due to hard fork, however, is a taxable event. Some people believe that if they don’t trade or cash out the hard fork coin that landed in their wallet or exchange account, they don’t need to report anything. That’s not true. Anytime you receive a new coin due to a hard fork, you need to report it as income.
Many crypto holders receive airdrop coins that are not related to a hard fork. However, the IRS FAQs and Rev. Rul. 2019-24 did not provide specific guidance about how to treat this type of income. In such a situation, we believe you can either report your airdrop coins as ordinary income in the same way that you would account for hard fork coins, or you can take a zero basis approach and record your airdrop coins as a purchase for zero dollars.
Spending cryptocurrency
If you spent cryptocurrency to pay for goods or services, under the current IRS guidance, you need to report those transactions on your tax return. Each spending transaction is treated as if you had sold your cryptocurrency for FMV in USD, then used the USD to pay for the product or service. All gains or losses will need to be recognized and reported.
On January 15, 2020, the Virtual Currency Tax Fairness Act of 2020 was introduced with bipartisan sponsors in Congress. The Act recommends that any disposal of cryptocurrency in a personal transaction that generates no more than $200 worth of gains should not trigger recognition of taxable income. However, even if the Act is passed and signed into law, taxpayers will still need to calculate the gain or loss of each spending transaction in order to determine if the transaction can be exempted from income taxation. They’ll also need to know how much they can deduct as well as how the transaction impacts the remaining cost basis of their crypto holdings.
Cryptocurrency gifting and donation
You do not need to report any cryptocurrency you received as a gift on your tax return until you sell, exchange or dispose of it for value. Your cost basis and holding period is usually the same as the donor’s. However, if you don’t know the donor’s cost basis or if it cannot be proved, your basis in the cryptocurrency you received is zero. Also, if you don’t know the donor's holding period, your holding period starts the day after you received the gift.
Gifting cryptocurrency to someone else is usually not a taxable event, unless the fair market value of the coin at the time of the gifting exceeds the annual exclusion for gifts amount (USD $15,000 in 2018, 2019 and 2020). If the value of the gift exceeds the limit, you may need to file a gift tax return, Form 709.
Cryptocurrency gifts and donations do not trigger capital gains or losses. If you make a charitable contribution with cryptocurrency, you can deduct up to the FMV of the coin you donated if you had held the coin for more than a year. Otherwise, you can only deduct the cost basis of the coin. You need to fill out Form 8283 if you donate more than $500 worth of cryptocurrency.
Tax Compliance Issues for Cryptocurrency Transactions
Crypto tax reports issued by crypto exchanges
One common misperception among crypto traders is that crypto tax reports issued by exchanges like Coinbase can be used to report crypto transactions at tax time. However, this only works if you use only that particular exchange and nothing else for your crypto transactions.
This screenshot taken from the Coinbase website outlines some situations in which their gain/loss calculator (and their tax report) will not be accurate:
So what’s the solution? As mentioned earlier in this article, if you have been using multiple crypto exchanges, or if you have been transferring coins among different accounts or you are involved in other crypto activities such as mining, ICOs, receiving or spending cryptocurrency etc., you need to use a crypto tax software to do your crypto tax calculation.
CoinTracking was the first crypto tax calculator to hit the market, and it’s still the leader in the space. One reason for this is that it has the most features. You are in good hands if you are using CoinTracking!
Can the IRS really catch me if I don’t report my crypto taxes?
Yes they can! Many mistakenly believe that cryptocurrency transactions are anonymous and that the IRS will not be able to catch them if they don’t report. That is simply not true.
Blockchain is an open ledger. The IRS has hired Chainalysis, an IT firm specializing in blockchain analysis, to scrub the blockchain and help identify people who did not report their crypto transactions.
In 2016, the IRS requested that Coinbase provide data on more than 14,000 of its users. Since then, Coinbase has been issuing Form 1099-Ks to users who have at least $20,000 worth of transactions or 200 or more transactions each year. Each Form 1099-K that Coinbase sends is also submitted to the IRS.
Several other U.S. crypto exchanges have followed in Coinbase’s footsteps. They have also started issuing Form 1099-Ks to their customers. If you’ve received a 1099-K from your crypto exchange, make sure to report your crypto transactions. Otherwise, you can fully expect to receive an IRS notice later.
The IRS has formed a task force focusing on enforcing cryptocurrency related tax compliance. The task force includes IRS criminal investigators. It’s a very risky decision to underreport or not to report your cryptocurrency transactions at all. It may lead to severe penalties, including criminal prosecution, five years in prison along with a fine of up to $250,000.
Where can I get help?
In order to help our users feel confident that they’ve reported their crypto activity correctly, we’ve developed a new service called CoinTracking Full-Service. Our partner Expert Crypto Tax Services is a crypto tax service firm that’s dedicated to serving CoinTracking customers.
The way it works is simple. After you import your crypto transactions to your CoinTracking account, you can contact our Full-Service team to get extra help. All you have to do is to fill out this form, and a crypto tax specialist will contact you to guide you through the process of reconciling your cryptocurrency transactions and preparing a correct crypto tax report for you to file with your tax return.
Our CT Full-Service team will:
- Assist you with importing all of your transactions.
- Check your data for completeness and accuracy.
- Help you add missing trades, deposits, withdrawals and other transactions.
- Provide you with guidance on how to record complicated transactions such as ICOs, lost or stolen coins, airdrops, gifts, etc.
- Create and review your CoinTracking tax reports.
- Help you with anything else that’s necessary to generate an accurate CoinTracking tax report.
If you are not sure if you really need CoinTracking Full-Service, we also offer a Crypto Tax Expert Review service.
Here is how it works:
- You pay a $150 flat fee for us to do a review of your CoinTracking account and your crypto tax reports.
- We provide you with a report, which contains a list of issues we identified in your account and our recommendations about what you can do to resolve them.
- You can either fix the issues yourself or you can hire our Full-Service team to help you.
Our Full-Service team works closely and directly with CoinTracking support team to make sure all your software related issues and reconciliation as well as tax related issues are covered.
If you have never reported your crypto transactions or if your tax preparer does not know how to handle your crypto tax reporting, our Full-Service team can help get you caught up. If you received an IRS warning letter or tax notice related to your crypto transactions, you should respond timely and carefully to avoid more severe consequences.
You never know what information the IRS already has about you. To get professional help, make sure you find a CPA or EA who is knowledgeable in cryptocurrency taxation and who has experience in mediating tax controversies.
Expert Crypto Tax Services can help you prepare amended tax return for prior years, do your current year tax return, provide you tax planning and consulting services, as well as help you handle any IRS notice you received. If you already have an accountant and you want to continue to use them for your traditional tax work, Expert Crypto Tax Services can work with your accountant and only handle your crypto tax work. If you are under IRS audit or if you have received an IRS notice and your case is very serious, you should consider hiring an attorney. Expert Crypto Tax Services partners with a tax attorney who has in-depth knowledge about cryptocurrency taxation and he has the experience and expertise to handle complicated tax controversy cases including criminal tax cases. We can work with the attorney to cover everything you need.
Final Words
Cryptocurrency transactions can be very complicated. The current IRS guidance covers certain areas but not all. There are still a lot of uncertainties and confusions. A few final pointers we would like to share with you:
- Get familiar with IRS rules about cryptocurrency taxation so that you don’t unknowingly get into any trouble.
- Follow the tax law and be compliant. Do not try to cheat the IRS. It is not worth the risk.
- Use a good crypto tax software platform that has all the features you need to generate a correct crypto tax report.
- Get professional help if you are not sure how to handle your crypto transactions. The price you pay now can save you a lot of time and money down the road.
- Use a competent and knowledgeable tax professional to help you handle your crypto taxes. Make sure they are familiar with different types of cryptocurrency activities and that they fully understand how to handle your situation.
- If you receive an IRS notice, do not ignore it or delay your response. Seek professional help as soon as possible.
Disclaimer
This article is for informational purposes only. It should not be construed as tax or legal or investment advice.
Please consult your tax advisor or attorney regarding your specific situation.