The ABCs of Cryptocurrency
We expect there to be major changes this year in how the IRS will enforce cryptocurrency gains. In this blog post we explore the definition of cryptocurrency and what you need to know about accounting for cryptocurrency transactions and reporting cryptocurrency gains on your 2018 tax return.
What is Cryptocurrency?
According to taxadviser.com, “Cryptocurrency is a digital currency. Its transactions occur through blockchain technology (a digital ledger) over a decentralized peer-to-peer network that takes the place of an intermediary. Cryptocurrency lacks legal tender status in nearly all jurisdictions, including the United States.”
Cryptocurrency can be stored in a digital “wallet” via a computer or smartphone app, or it can be held in a digital account on the blockchain where account holders can exchange their cryptocurrency for other types of digital currency or for traditional currency such as the U.S. Dollar, the Euro, etc.
The most well-known form of digital money is bitcoin. Other popular cryptocurrencies include Litecoin, ripple and Ethereum. Digital currency is passed from online wallet to online wallet via an unregulated network that poses great challenges to banks, governments and law enforcement agencies that are still trying to determine how to deal with them. Digital currency has an assigned value at any point in time, much like a foreign currency has an exchange rate at a given time or a stock has a value at a given time.
Accounting for Cryptocurrency
For federal tax purposes cryptocurrency is considered property. Tax principles that apply to property apply to cryptocurrency. Here are some basic rules to familiarize yourself with:
- Cryptocurrency is not considered currency in the determination of losses or gains.
- Taxpayers must report the fair market value of the cryptocurrency as taxable income when it is used to pay for goods or services.
- Fair market value is determined as of the date exchanged for U.S. dollars.
- A taxpayer can show a virtual loss or gain.
- It is important to maintain accurate records of crypto transactions in order to be able to calculate crypto gains and losses.
To accurately calculate your digital currency gains or losses, be sure to record the value of the cryptocurrency at the time you acquire it, as well as at the time you exchange it, much like you would record a gain or loss on a stock transaction.
A cryptocurrency transaction is like a stock transaction, except that in the crypto world, you are exchanging the digital money for goods or services
Fortune Magazine provided some very helpful FAQs in this article from January, 2018. http://fortune.com/2018/01/29/bitcoin-taxes-cryptocurrency-irs/
1. If I made money on cryptocurrency transactions, how much do I have to pay?
Since the IRS views cryptocurrency as property like shares of stock or physical assets, you will be responsible for the long-term capital gains rate (typically 20%) if you sold it after a year, or the ordinary income tax rate if you sold it before a year.
2. How do I show a loss on cryptocurrency?
If you have a net loss in cryptocurrency, the IRS will allow you to use the loss to offset your capital gains or up to $3,000 of ordinary income. Any losses in excess of $3,000 can be carried forward to next year.
3. What if I exchanged some of my cryptocurrency with a store or another person?
The IRS views any divestiture of cryptocurrency as a “taxable event.” It doesn’t matter if you sold some of your bitcoin for cash, another cryptocurrency, or for a product or service. If it was worth more than you paid for it at the time of the exchange, you owe tax on the gain.
4. How do I declare cryptocurrency earnings?
All cryptocurrency earnings should be declared on Form 8949 to get a sum total, and then reported on your Schedule D, along with any other capital gains you have.
5. Can I donate cryptocurrency to a charity to reduce my tax bill?
You can donate cryptocurrency to a charity but there are specific rules and regulations that need to be considered.
Whether you’re venturing into the world of cryptocurrency, or simply need help sorting out traditional business or personal income and expenses for the 2018 tax year, your tax advisors at Diamond & Associates, PC CPAs can help.