Tax time is upon us! With W-2s and 1099s arriving in the mail on what seems like a daily basis, I wanted to address the unique tax issues associated with what has become a global phenomenon, crypto assets.
What Are Crypto Assets?
Basically, a crypto asset is a virtual item (or digital representation) that has value out in the marketplace. The best example is cryptocurrency, and the most well-known virtual currency is Bitcoin. The main characteristics of a virtual currency are that it has a store of value (think of it like a virtual representation of gold). It also is a transactional medium of exchange (it is used to buy stuff).
While digital currency is the most popular, there are other forms of crypto assets. One that I think we will see more and more of is called a nonfungible token (NFT). Yes, when I was first introduced to these, my response was how much bleach is used to clean that up!
My best analogy of an NFT is to think about it like a virtual baseball trading card. Just like any collectible, the beauty (or value) is in the eye of the beholder. Other types of NFTs are digital replicas of real-world items such artwork or even real estate. Imagine owning a Manhattan city block only in digital form!
Now that we have at least a very basic introduction to crypto assets, what are the tax issues involved with these?
How Does the IRS View Crypto?
Generally, for tax purposes, the Internal Revenue Service (IRS) views a crypto asset as property (just like a security or piece of real estate) with some unique nuances. For an NFT, the IRS’s view seems to match very well since these are digital representations of real-world assets, like real property and other collectibles.
However, for cryptocurrencies, the tax treatment as property is somewhat unique. The IRS does not view virtual currency the same as traditional currency, such as the U.S. dollar. As with property, when you exchange Cryptocurrency, you are taxed the same as when you sell a capital asset. The associated tax rules as I outline below will apply. This does not necessarily happen when exchanging standard forms of currency.
Do Crypto Assets Have To Be Disclosed To The IRS?
Starting a few years ago, the IRS added a seemingly benign question on the 1040 individual tax form. They are asking for taxpayers to disclose if they have received or disposed of a crypto asset during the year. Crypto asset exchanges are for the most part decentralized out on the web. So, the IRS is requiring self-reporting in order to collect information about these assets and related transactions.
One interesting point to note, according to the IRS’s most recently posted FAQs, if you simply purchase a crypto asset with real currency, then you can actually answer “no” to the disclosure question on the tax return. The logic behind this is that the term “receive” is not the same as a “purchase” of a crypto asset.
What Happens If You Sell Crypto Assets?
Although this area is just beginning to really take off, the IRS has already issued some guidance on the tax implications involved if you actually sell crypto assets.
First, the cost that you originally acquired the crypto asset for must be calculated. Whether you purchased it outright or “earned” it somehow will impact your cost basis when you sell the asset. A friendly caution here: If you are given cryptocurrency for free, say from an online brokerage, it is income. As such, it is reportable, but you then will have a cost basis if and when you sell it.
Additionally, the capital gain / loss tax rules will apply for most transactions related to the sale or exchange of a crypto asset. The good news here is that some of the gain may be eligible for reduced tax rates depending on how long the asset was held. Alternately, some of the losses may not be deductible in the current year.
Finally, a real hidden gem exists in all this technical jargon. Since crypto asset exchanges are classified as a property transaction, they can be sold and reacquired within any timeframe. The so called “wash-sale rules” that all savvy investors are aware of do not currently apply to crypto asset transactions. With the wild swings in Bitcoin pricing, for example, investors can offset gains with losses. They can then be able to buy back their cryptocurrency in order to ride the market back up – at least hopefully!
While the intangible nature of crypto assets makes them a bit more complicated, understanding the tax implications can help to save significant tax dollars. As always, your best bet is to get help from a qualified tax professional. Here’s to going Crypto!
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David W Clark, MPA, CPA
West Texas A&M University