Should governments tax cryptocurrency?

Should governments tax cryptocurrency?


Cryptocurrency is a digital currency, or a “digital representation of value,” as the IRS puts it. You can’t see it, hold it in your hand, or put it in your wallet. It’s been in use for over a decade and has grown in popularity over the last few years. Instead of using a bank to create, transfer, and exchange funds, cryptocurrency employs a distributed, encrypted blockchain network to process transactions. No bank or government authority controls it as they do with traditional currencies. So, if you have used cryptocurrency this year, what are the implications for when you file your taxes?

A Cryptocurrency Primer

First of all, let's make sure we're all on the same page when it comes to this new kind of money. Cryptocurrency units are referred to as coins, even though there’s no physical coin. You store coins in a digital wallet or use an exchange or brokerage. Major providers of these include Coinbase, Kraken, Binance, and Jaxx. Bitcoin was the first cryptocurrency and it remains the most popular, though it’s been joined by Ethereum and Litecoin, among others. Cryptocurrency can be used to pay for goods or services, to invest, or simply to exchange funds with someone else. The coins can also be exchanged for traditional currency. Cryptocurrency transactions are recorded in an anonymized blockchain, which can be thought of as a digitized public ledger.

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This form of money is still in its infancy, so don’t expect to use it for online shopping, though some vendors have started accepting it. It’s fairly popular among online gambling sites, and you could even buy a Lamborghini with it. Some employers, too, have started paying employees with it; the dollar value of the cryptocurrency at the time of the transaction is treated as W-2 or 1099 income. The mechanics of using cryptocurrency are often as simple as scanning a QR code or copy and pasting a long ID, but what happens in the background is far more involved than your typical bank transaction, since the transaction has to be verified by lots of distributed servers, rather than one bank or exchange.

Cryptocurrency as Property

If you’ve been using cryptocurrency, but not paying taxes on its related transactions, you’re not alone. You’re also not compliant with IRS regulations, which could catch up with you someday. The agency may penalize you unless you can prove “reasonable cause.”

Since 2014, the IRS has considered cryptocurrency to be property. Taxpayers are required to report transactions involving virtual currency as US dollars on their tax returns, which means they must determine its fair market value as of the transaction date. You can determine fair market value by converting the virtual currency into US dollars or into another currency that can then be converted into US dollars (this is assuming the currency’s exchange rate is established by market supply and demand).

Obviously, you need to do some seriously precise bookkeeping if you’re planning to use cryptocurrency. There are several accounting solutions designed for this, but QuickBooks may work just fine for you (with some workarounds). You should start keeping detailed records from the start, since reconstructing years of transactions could be difficult, or even impossible.

Capital Assets and Cryptocurrency

If you sell your home because you’re moving or some stocks because you want to take your profit, these properties are considered capital assets. It’s similar for virtual currencies. You pay capital gains taxes on them—either short (held less than a year, and taxed as normal income) or long term—on your Schedule D. These are calculated just like other capital gains and losses: You take your cost basis (the amount you paid for the currency) and calculate how much it’s gone up or down since that date. Capital gains rates for the 2019 tax year can be 0, 15, or 20 percent, depending on your taxable income.

If you’re selling property as a part of a business or trade, however, the property is not considered a capital asset and is taxed as ordinary income. This applies to virtual currency sales, too. The IRS looks at the “character” of the gain or loss—your intent, or why you’re selling.

Cryptocurrency and TurboTax

TurboTax (buy) is the only tax preparation website that walks you through the process of recording a cryptocurrency sale. It does so thoroughly and with lots of guidance. This tax topic is not included in the Deluxe version, though. You’ll have to spring for Premier or Self-Employed.

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