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Tax Considerations for Cryptocurrency

In February 2018 we published a Tax Alert with guidance on the tax treatment for CryptoCurrency, such as Bitcoin and Ethereum. This past summer, the IRS began reaching out to Coinbase customers for information regarding their Crypto transactions. So the IRS is getting serious.

Last week, the IRS announced two additional initiatives to track down Crypto activities.

New Question Added to the 2019 Form 1040

The IRS recently issued a draft of the Form 1040 proposed for use by individual taxpayers when they file next year to report 2019 income and deductions. On the draft of Schedule 1 is included the following question:

"At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?"

New Crypto Guidance from IRS

In addition to the proposed question on the 2019 form 1040, IRS also issued updated guidance on the treatment and taxation of virtual currencies in the form of FAQs. Summarized below are the highlights.
Receipt of Digital Currency for Goods and Services
Being paid in the form of a digital currency for rendering a service or providing a product results in ordinary income. The business revenue would typically be based on the fair market value of the currency at the time of the transaction. This value becomes the cost basis for the currency for future transactions.
Using Digital Currency to Purchase Goods and Services
Since digital currency is treated as property for tax purposes, the capital gain holding periods govern the taxation of any imputed gain or loss. A coin position held for more than a year qualifies for long-term capital gain treatment, while a coin position held a year or less results in short-term capital gain treatment.

When the coin position is liquidated to purchase property, the difference between the cost basis of the coin position and the fair market of the property creates a gain or loss. Hence, the fair market value of the property becomes its cost basis for future transactions.

The holding period between the time the coin position was established and the time of liquidation determines the long-term or short-term nature of the gain or loss.
Now to Determine Fair Market Value
The FAQs provide guidance on determining fair market value for virtual currencies:
  • When obtained through a currency exchange, it is the amount recorded by the exchange using US dollars.
  • When obtained through a peer-to-peer transaction, it is the amount recorded on the distributed ledger.
  • Use of a cryptocurrency or blockchain explorer can be used to substantiate fair market value.
Specific Identification of Virtual Currency Transactions
When selling or exchanging virtual currency, taxpayers with multiple units obtained at different times may choose, or specifically identify which units are being sold or exchanged. Absent this, the fallback is the use of first-in, first-out (FIFO) reporting.
Tax Reporting
In the FAQs, IRS reminded taxpayers to report capital gains and losses from virtual currency transactions on their annual tax returns.


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