In the past few years, we have had clients with unpleasant tax surprises related to their virtual currency. We put together the guide to help them understand the tax treatment of virtual currency that is earned, converted into, or exchanged for, real currency. And know we are sharing this with you.
Income is generally taxable regardless of the source it comes from. As such, virtual currency transactions are taxable just like ‘traditional’ transactions involving money for goods or services, or an exchange of property for other property or services. Virtual currency is also treated as property by the IRS and general tax principles that apply to property transactions apply if you sell, exchange, or otherwise transact using virtual currency.
## What virtual currency transactions are taxable?
The following items illustrate several common transactions involving virtual currency:
**Earnings:** When you receive virtual currency in exchange for performing services, you must report the earnings as ordinary income. Virtual currency as wages must be reported by your employer on Form W-2. If you receive virtual currency in return for providing services and are not an employee, this income from self-employment is often reported on Form 1099-NEC. You must report income from all taxable transactions involving virtual currency on your Federal income tax return for the year of the transaction, regardless of the amount or whether you receive a payee statement (like a Form W-2) or information return (like a Form 1099-NEC)
**Sales:** When you sell virtual currency, it is generally a capital asset and you must report the transaction along with any capital gain or loss on the sale. This includes gains on virtual currency received as earnings.
**Exchanges:** If you exchange virtual currency held as a capital asset for services or other property, including goods or another virtual currency, you must report the transaction and any capital gain or loss resulting from the exchange.
**Hard forks:** A hard fork occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency in addition to the legacy cryptocurrency. If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency you don’t have taxable income.
## What virtual currency transactions are not taxable?
Not all property transactions are taxable. the following transactions are not taxable:
**Transactions with yourself**. If you transfer the same virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you, the transfer is a non-taxable event, even if you receive an information return reporting the transfer.
**Bona fide gifts.** If you receive virtual currency as a bona fide gift, the gift is not taxable. You will report any income or loss when you sell, exchange, or otherwise dispose of the virtual currency.
**Charitable donations.** If you donate virtual currency to a charitable organization described in Internal Revenue Code Section 170(c), you will not report income, gain, or loss from the donation. As an added bonus, you get a charitable deduction for the value of the virtual currency on the date of the gift, not your original cost. This means you get a larger tax deduction and no capital gain which is much better than selling and donating the cash.
**Soft forks.** A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency. Because soft forks do not result in you receiving new cryptocurrency, you will be in the same position you were in prior to the soft fork, meaning that the soft fork will not result in any income to you.
## Where Are Virtual Currency Transactions Reported?
Transactions conducted in virtual currency are generally reported on the same tax forms as transactions in other property.
You must report ordinary income when paid in virtual currency in exchange for services or goods as you would if you were paid in cash.
Beginning in 2020, if you engage in any transaction involving virtual currency, check the “Yes” box next to the question on virtual currency on page 1 of Form 1040 or Form 1040-SR, even if you received virtual currency for free, including from an air-drop or hard fork. Do not check this box if you only engaged in transactions with yourself.
You must report most sales and other capital transactions and calculate the capital gain or loss in accordance with IRS forms and instructions, including on Form 8949, and then summarize capital gains and deductible capital losses on Schedule D.
If you still have some doubts, please don't hesitate contacting us for more information.
