Taxation of Cryptocurrency Transactions

February 6, 2020

The IRS recently issued new cryptocurrency guidance and is intensifying its efforts to identify taxpayers who bought or sold cryptocurrency and didn’t report it on their tax return.  The following is a brief overview of the clarifications made.

What is the tax treatment of Cryptocurrency transactions?

For tax purposes, cryptocurrency is treated as property

  • If you receive cryptocurrency in exchange for services, then realized income is the fair market value of the cryptocurrency received. Basis in the cryptocurrency received is its fair market value at the time of receipt plus any transaction fees incurred.
  • If you receive cryptocurrency in exchange for property, then gain or loss realized is the fair market value of the cryptocurrency received less the adjusted basis of the property given up. Basis in the cryptocurrency received is the fair market value at the time of receipt plus any transaction fees incurred.

Unless you are a trader, for tax purposes, cryptocurrency is treated as a capital asset. Therefore, taxes are paid on gains and losses are subject to the capital loss limitation rules.

  • If you give cryptocurrency in exchange for services, the value of the expense is the fair market value of the cryptocurrency given. You will also have a taxable event on disposal of the cryptocurrency given.  The value of the services received less the adjusted basis of the cryptocurrency will be either a capital gain or loss.
  • If you give cryptocurrency in exchange for property, the capital gain or loss on disposal of the cryptocurrency is the fair market value of the property received less the adjusted basis of the cryptocurrency.  Basis in the property received is the fair market value of the cryptocurrency given.

Hard Forks

In the cryptocurrency world, a hard fork occurs when the digital register that logs transactions of a particular cryptocurrency diverges into a new digital register. There are two types of hard forks:

  • one in which you don’t get cryptocurrency, and
  • one in which you get new cryptocurrency.

The IRS has ruled that:

  • a hard fork in which you don’t get cryptocurrency is not a taxable event, and
  • a hard fork in which you get new cryptocurrency is a taxable event. Ordinary income is recognized equal to the fair market value of the new cryptocurrency received.

Specific Identification

When selling property, it is generally sold on a first-in, first-out (FIFO) basis unless the seller is eligible to use the specific identification method. The specific identification method is preferred because the seller has control over the amount of gain or loss the sale will generate. With FIFO, the seller does not have a choice.

To use the specific identification method, the seller has to either:

  • document the specific unit’s unique digital identifier, such as a private key, public key, and address, or
  • keep records showing the transaction information for all units of a specific virtual currency, such as bitcoin, held in a single account, wallet, or address.

This information must show:

  • the date and time each unit was acquired;
  • basis and the fair market value of each unit at the time it was acquired;
  • the date and time each unit was sold, exchanged, or otherwise disposed of; 
  • the fair market value of each unit when sold, exchanged, or disposed of; and
  • the amount of money or the value of property received for each unit.

We encourage you to read the IRS’s Frequently Asked Questions on Virtual Currency Transactions to learn more about complying with the reporting requirements.

Do not hesitate to reach out to your Beaird Harris advisor to discuss your specific situation.