It’s no secret that cryptocurrencies have been a hot topic in the news lately.
So, what do people mean when they talk about “cryptocurrency”?
Cryptocurrency is a digital or virtual currency that uses cryptography for security. Cryptocurrencies are decentralized, or not subject to government or financial institution control. Bitcoin, the first and most well-known cryptocurrency, hit the market in 2009.
With the recent rise in the value of Bitcoin, Ethereum, and other digital assets, more and more people are looking to get involved in the crypto market. Are you one of them?
If you’ve invested in cryptocurrency this year, there’s a couple of things you’ll need to make your accountant aware of at tax time. Here’s a quick rundown of some of the questions he or she will likely ask about your crypto investments.
What type of cryptocurrency do you hold?
The first question your accountant will ask is what type of cryptocurrency you own. There are many different types of cryptocurrency, and each has its own tax implications. For example, Bitcoin is considered a capital asset, while Ethereum is considered property. Knowing the kind of cryptocurrency you own will help your accountant determine how to correctly report it on your taxes.
The IRS currently recognizes two types of virtual currencies: convertible and non-convertible. Convertible virtual currency can be exchanged for real or other virtual currency, while non-convertible virtual currency does not have that ability. Currently, Bitcoin is the only form of cryptocurrency classified as convertible.
How much did you pay for your cryptocurrency?
There’s no doubt that your accountant will ask about your “basis” or how much you paid for the cryptocurrency. This is important in calculating your capital gain or loss. Your profit or loss is determined by subtracting your basis (i.e., what you paid for the asset) from the proceeds (i.e., what you sold it for). So, for example, if you bought a Bitcoin for $1,000 and sold it later for $2,000, you would have a capital gain of $1,000.
When did you purchase the cryptocurrency?
Another critical question you’ll need to answer for your accountant is when you purchased your cryptocurrency. This is important because it will determine whether you receive long-term or short-term capital gains treatment.
Long-term capital gains apply to assets held for more than one year, while short-term capital gains apply to assets held for one year or less. That matters because long-term capital gains are subject to lower tax rates than short-term capital gains.
Sound confusing? This example may help –
Imagine that you held your cryptocurrency for less than a year before selling it. If that’s the case then any profits you made will be considered short-term capital gains and taxed accordingly (at a higher rate). However, if you held onto your cryptocurrency for more than a year, your earnings will be regarded as long-term capital gains and taxed at a lower rate.
Did you donate any cryptocurrency to charity?
If you donated cryptocurrency to charity, you might be eligible to take a charitable deduction on your taxes. The deduction amount will depend on the cryptocurrency’s fair market value at the time that you donated it.
Have you used cryptocurrency to purchase goods or services?
If you have used cryptocurrency to purchase goods or services, you may be required to pay taxes on those transactions. For example, if you use Bitcoin to buy a coffee, you would be responsible for paying any applicable sales tax on the transaction.
Do you have plans to use or sell your cryptocurrency?
If you’re thinking about using your cryptocurrency to purchase goods or services in the future, your accountant will want to know about it. This information is essential because it will help them determine whether or not you are subject to capital gains taxes.
For example, as mentioned above, if you sell the cryptocurrency within a year of buying it, then any profits you make will be considered short-term capital gains and taxed accordingly. However, if you hold onto the cryptocurrency for more than a year before selling it, your profits will be regarded as long-term capital gains and taxed at a lower rate.
For this reason, once you do let your accountant know about your crypto investment, he or she will likely recommend that you hang onto it for at least a year so that you can meet the lower tax threshold when you sell. On top of that, you should let your accountant know if you bought cryptocurrency, and then reinvested it in additional crypto. That’s because it would technically count as a sale.
Did you receive any cryptocurrency as compensation?
If you receive cryptocurrency as compensation for goods or services, it is considered taxable income and must be included in your gross income. The cryptocurrency’s fair market value at the time you received the payment will be what your accountant uses to calculate your capital gain or loss.
Have you ever sold or “cashed out” your cryptocurrency?
If you have sold any cryptocurrencies, your accountant will want to know about it. This information is crucial because it will determine your capital gains (or losses). For example, similar to the previous model, if you bought Bitcoin for $5,000 and sold it later for $10,000, you would have a capital gain of $5,000.
Whenever you exchange cryptocurrency for fiat currency (i.e., real currency like USD), you are considered to have sold your cryptocurrency. Therefore, you must calculate any resulting capital gain or loss just as you would if you had sold any other type of asset.
Do you have any losses?
If you sold cryptocurrency at a loss, you might be able to claim a capital loss deduction on your taxes. Capital losses can offset capital gains, and if your total capital losses for the year exceed your total capital gains, you may be able to use up to $3,000 of the excess to offset other types of income. Any remaining losses can be carried forward to future tax years.
Do you have any other questions about claiming cryptocurrency on your taxes?
If you have any other questions about claiming cryptocurrency on your taxes, feel free to ask our friendly staff and Remote Accounting Experts. Contact us today, and we can help you figure out what information is essential and how it should be reported on your tax return!
As you can see, a lot goes into calculating your tax liability for cryptocurrency. Cryptocurrency can be a confusing topic, but many resources are available to help you understand it better. Make sure you keep good records throughout the year and consult with a qualified tax professional come tax time.
With a bit of preparation and the help of our qualified staff at Remote Accounting Experts, you can ensure that everything goes smoothly come Tax Day!
This article is for informational purposes only and does not constitute tax advice. If you have any questions about how cryptocurrency will affect your taxes, speak with a qualified accountant or tax professional.