The first cryptocurrencies were launched 15 years ago, and over that short time frame these digital assets have attracted more than $1 trillion in investments, according to some estimates.
“Virtual currency is now so mainstream it cannot be ignored,” said the National Association of Tax Professionals in a recent commentary.
The Internal Revenue Service certainly isn’t turning a blind eye and in recent years has required taxpayers to certify whether they have engaged in cryptocurrency trading.
“As the IRS continues to issue new guidance," the association of tax pros said, "it is important taxpayers understand the tax consequences of transactions involving virtual currency.”
In addition, the Securities and Exchange Commission recently allowed a new type of cryptocurrency investment to begin trading, and that could expand popularity for these assets.
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What is cryptocurrency?
Digital or crypto assets, according to the IRS, are “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.” The IRS-watchdog Taxpayer Advocate Service describes them as currencies that use cryptography to secure transactions and a decentralized system to record transactions and issue new units.
Digital assets hold appeal for various reasons. In particular, they're not directly linked to traditional currencies and thus can be seen as a different type of asset that stores value, usually with limited supplies of them. Bitcoin is the biggest and probably best-known example.
Digital assets include “non-fungible tokens,” or NFTs, where non-fungible refers to something that is unique and can’t be replaced, noted the Taxpayer Advocate Service. Every NFT contains a digital signature that makes it unique, the agency said. “By contrast, a fungible item is one whose individual units are essentially interchangeable. Physical currency is fungible, which means a $100 note is indistinguishable from and has the same value as any other $100 note.”
An NFT can represent a digital asset or it can track the value of other assets such as a home, car or even intellectual property such as a song.
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How is crypto taxed?
Income is generally taxable regardless of its source, noted the Taxpayer Advocate Service. “As such, digital asset transactions are taxable just like ‘traditional’ transactions involving money for goods or services, or an exchange of property," the advocate service said. "Digital assets are treated as property by the IRS.”
As such, sales or exchanges trigger capital gains or losses. Meanwhile, digital assets received as payment for services are treated like wages, as ordinary income.
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What are some examples?
The Taxpayer Advocate Service provides some simple examples. Suppose you bought five Bitcoins for $50,000 and sold them two months later for $52,000. The $2,000 profit would be a short-term gain (held less than a full year) and thus taxable at ordinary-income rates.
Alternatively, if you exchanged a digital asset for other assets, goods or services, you would report a capital gain or loss reflecting the “difference between the fair market value of the property or service you received and the basis of the property given up,” the Taxpayer Advocate Service said, where basis reflects what you paid. So if you bought five Bitcoins for $50,000 and sold them two months later for another virtual currency for $40,000, you would have a $10,000 short-term loss.
As another example, suppose you received 10 Bitcoins worth $100,000 for providing work as an employee. You would report these as “wages” on your tax return. If not an employee, would you report this elsewhere on your tax return, but the transactions still would be taxable.
What if I didn’t have any dealings with digital assets?
In that case, answer “no” to the question on your Form 1040 asking if you have engaged in certain digital-asset transactions. If you did, you must check “yes” on the box.
“You need to report this,” said Tom Wheelwright, a certified public accountant and financial author at Wealth Ability in Tempe. “If you don’t do that, it’s fraud and you can be criminally prosecuted.”
The question essentially asks whether you, at any time during 2023, received, sold, exchanged or otherwise disposed of a digital asset.
What's new with crypto investing?
The Securities and Exchange Commission in early January started to allow exchange-traded funds to hold Bitcoins directly, though the agency didn't endorse these investments as favorable or promising. This approval could boost the popularity of digital assets by making them more convenient to buy or and sell, Wheelwright said. Some earlier funds invested in crypto but did so through futures contracts, a more indirect form of ownership, he explained.
But while more people will find it easier to trade or invest in digital assets, that doesn't necessarily translate to profits, Wheelwright noted. Bitcoins, for example, have exhibited substantial price volatility and currently trade around $43,000 per coin, up from $16,000 or so one year ago but down from a peak near $64,000 in 2021.
"I think more people will buy Bitcoins," Wheelwright said, but he added that future price trends are anyone's guess.
Reach the writer at russ.wiles@arizonarepublic.com.
