Personal tax filings for the year 2021 are due in a month. Many Americans will file an extension to allow for more time to produce their records, but one issue that will be different in this year’s filings is that millions of Americans will have new exposure to and transactions in cryptocurrencies for the first time ever. The good news is that the IRS isn’t going after people just because they own cryptocurrency. The bad news is that the tax laws are new and may change rapidly in this space — and in some ways the rules may just feel overly burdensome.

Collectors Dashboard is not a tax service, and we are not representing this information as tax advice. We do consider Bitcoin and other cryptocurrencies in the same light as traditional investments and alternative assets, but the reality is that the tax ramifications may vary wildly from person to person. If there is one solid lesson here — keep ultra-clean record of your buys and sells and make sure you understand you adjusted cost basis in each virtual currency and cryptocurrency you have bought or sold.

These are just some of the basics and each owner of crypto needs to seek out professional tax advice. Please read our DISCLAIMER below.

CLEAN RECORD KEEPING IS A MUST

What crypto investors and HODLrs need to keep in mind is that it is imperative to keep clean records about when and where each transaction was made. Buying may not result in a taxable event if the assets are never sold, but selling for gains and losses comes with tax ramifications. Even using crypto for trade or purchase can trigger a taxable situation.

With a universe of more than 10,000 digital assets classified as crypto and with a market that had been worth over $2 trillion, there is a lot to keep up with. And if you aren’t keeping up with it you can probably bet that the IRS will be keeping up with you to provide information and pay your “fair share.”

HOW THE IRS RECOGNIZES CRYPTO

If you bought cryptocurrency any time before 2021 and decided some time last October or early in November that it was just getting too frothy then you are going to have gains to report. First and foremost, the IRS treats cryptocurrencies as property — so the end result is capital gains taxes rather than income taxes. According to the IRS current recognition guidelines:

Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency.

CRYPTO FOR PURCHASES CREATES A TAXABLE EVENT

Using a cryptocurrency to pay for a purchase also counts as a sale at whatever conversion price was used. Spending $500 for a coat at the store in cash is effectively cash being used at the same valuation. Spending $500 worth of Bitcoin that only cost you $150 means there is $350 that will be treated as gains on top of that.

Effectively, this would be the fair market value of the goods or services you are purchasing versus your average cost basis as well as any associated fees (commissions, transfers etc.). According to the IRS:

When you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses.

LONG-TERM GAINS VS. SHORT-TERM GAINS

There is a definite issue with long-term gains (and losses) versus short-term gains (and losses). This is relatively similar to stocks, bonds and other property. The IRS defines these as follows:

If you held the virtual currency for one year or less before selling or exchanging the virtual currency, then you will have a short-term capital gain or loss. If you held the virtual currency for more than one year before selling or exchanging it, then you will have a long-term capital gain or loss. The period during which you held the virtual currency (known as the “holding period”) begins on the day after you acquired the virtual currency and ends on the day you sell or exchange the virtual currency.

TRACKING YOUR ADJUSTED COST BASIS

The IRS lays out how to keep track of your adjusted cost basis. If you bought high in 2021 and have been buying in 2022, your adjusted cost basis may keep drifting lower. If you bought years ago and added the same assets over time, your adjusted cost basis has likely risen. The IRS says:

Your gain or loss will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, which you should report on your Federal income tax return in U.S. dollars… our basis (also known as your “cost basis”) is the amount you spent to acquire the virtual currency, including fees, commissions and other acquisition costs in U.S. dollars. Your adjusted basis is your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars.

LARGER PURCHASES CREATE EVEN LARGER TAXABLE EVENTS

What if you used your crypto to purchase a car? This is no longer unheard of. If you were to buy a $50,000 car with crypto (let’s just assume Bitcoin for an easier example) but the Bitcoin was worth only $25,000 when you purchased it through an exchange or brokerage, you are still paying the $50,000 stated value at the time plus there are $25,000 in taxable gains that would be a result. The good news is that your after-tax cost basis is still much lower if you only consider your investment amount. The bad news is that you are going to have to pay the IRS thousands in capital gains on top of your car purchase.

If your cost basis was $60,000 for the Bitcoin, the purchase price of $50,000 would result in a $10,000 loss that could then be used to offset other long-term capital gains or taxable income in the same tax-year depending upon the time you owned it.

THE BURDEN OF PROOF IS ALL ON HODLrs!

Many crypto exchanges will not be sending out a Form 1099 to crypto-owners. That means that it’s up to each HODLr individually to keep track of buys and sells (or buys and exchanges if for goods and services). And it is each owner’s responsibility to report (or be able to prove) each transaction to the IRS.

TRANSFERS AND SWAPS MAY BE TAXABLE TOO

It is not uncommon for a crypto buyer to switch from one coin to another. Again, there are thousands of them and we all have seen how some can move exponentially higher even on days where Bitcoin or Ethereum are not moving that much. Bailing out of one to then buy into another may be no different than locking in some gains and Apple and using the funds to buy Amazon, Alphabet or even the S&P 500 for more diversity. This means that taxes have to be paid on the gains, or the losses can be used to offset other gains in the same tax year.

Transferring one same cryptocurrency from one exchange over to another may not create a taxable event, but the owner has to show proof that it was a transfer.

ARE THERE TAX-FREE CRYPTO ACCOUNTS?

A more recent move for crypto buying tax-free (for now) is to open what you have heard advertised as Crypto-IRA account. We cannot speak on behalf of nor against any of these financial entities because we haven’t used them. If they work the way they are advertised then it means the buys and sells do not have to be kept up with the same as if it is in a taxable account. Then again, whenever you start to withdraw funds against those assets decades into the future the full withdrawal will be taxed as income regardless of whether your gains are 10x your investment of whether they were at a 90% loss. And if you withdraw those retirement assets early because of life’s interruptions it may result in penalties as well.

WHERE CRYPTO GETS REAL EXPENSIVE IN TAXES

Let’s just assume that a crypto HODLr has owned Bitcoin for years and years through an exchange that is no longer operating. Assuming you were able to get your money out, it is the individual’s responsibility of proving a purchase price. Otherwise come sale time or exchange time with no provable adjusted cost basis –the IRS can treat the entire sale as a taxable gain.

TAX EVASION DOESN’T HAVE TO BE INTENTIONAL

Most of us think of tax evasion as a deliberate effort to not pay taxes. Well, oversight, failing to remember, or even the wrong estimates used can land you in a tax evasion case whether the effort was intentional or not. You are entitled to use the tax code to your biggest advantages each year, but you are required to do that lawfully and you are required to pay those taxes due.

HAVE YOU HUGGED A CPA TODAY?

As millions of new HODLrs come to grips with owning crypto and digital assets for the first time in 2021, there are going to be many instances where a large number of transactions to buy and sell crypto have to be reconciled. This means that some kids in college are going to have to prove a lot on or after April 18, 2022. There may need to be an entirely new army of tax pros and tax programs needed to help HODLrs with their taxes in the new crypto world.

SOME REMINDERS BY THE IRS DIRECTLY

The IRS has issued guidelines for cryptocurrencies. These are formal guidelines, but they may of course change over time (or suddenly as has been seen other nations). We have taken some of these issues below to further outline efforts not mentioned above.

Defining virtual currency — Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value…. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.

For sales, exchanges, use as payment for goods/services — The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.

Do you have to report only purchases of virtual currencies with real currency? — QUESTION: Q5(a). The 2021 Form 1040 asks whether at any time during 2021, I received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. During 2021, I purchased virtual currency with real currency and had no other virtual currency transactions during the year. How do I answer the question on the Form 1040? (added March 10, 2022)… ANSWER: A5(a). If your only transactions involving virtual currency during 2021 were purchases of virtual currency with real currency, you are not required to answer “yes” to the Form 1040 question, and should, instead, check the “no” box.

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DISCLAIMER: Please understand that this effort is only intended to be a starting point for the most basic tax assumptions in cryptocurrency and virtual currencies. This is NOT INTENDED TO BE TAX ADVICE and some of the information even under the formal IRS guidelines may have already changed. Tax laws are constantly changing in the virtual and crypto space and it is the sole responsibility of each investor to seek professional tax advice as it pertains to their own situation. Collectors Dashboard accepts no credit nor any liability for the information that has been provided.