Investing in cryptocurrency and, more recently, NFTs (non-fungible tokens), has exploded in popularity. While it’s exciting to enter a new market, it’s imperative that you document your activity properly.
Cryptocurrency Events – What’s Taxable?
The IRS continues to keep an ever-closer eye on cryptocurrency activity. It’s important to know when your activity qualifies as a taxable event and what types of documentation the IRS expects at tax time.
Buying Cryptocurrency is NOT a taxable event
To start: good news, just buying cryptocurrency with USD is not a taxable event. You will need to report your subsequent cryptocurrency activity on your 2021 tax return, however. The 2021 Form 1040 is updated to read “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”. It is important to note that if you purchased crypto with USD and held that cryptocurrency throughout the year, you do not have to check the box. The term “receive” relates to if you were sent crypto that wasn’t an original purchase with the USD.
Cryptocurrency Mining IS a taxable event
Mining is the process of creating new crypto (applies to proof of work, PoW, cryptos) by solving complex mathematical equations in order to approve transactions on the blockchain. The cryptocurrency you get in return for doing this is called a “block reward”.
This mining is a taxable event. When a crypto is successfully mined, you report the fair market value at the time of the mine as ordinary income. If you report on Schedule C, this is also subject to self-employment tax. When you mine a crypto and recognize as income, that becomes your basis in the crypto. This is relevant for when you sell the bitcoin in regard to calculating your gain or loss.
It is also a taxable event when you are paid as an employee or subcontractor via cryptocurrency. These must be reported on your income tax return as ordinary income and will be subject to the same taxation rules as if the compensation was paid in USD.
Cryptocurrency staking MIGHT be a taxable event
At a base level, cryptocurrency staking is a way to earn rewards for holding certain types of cryptocurrencies. Not all cryptocurrencies allow for staking. The taxation of staking rewards is a hot topic with the IRS right now as there is no definitive IRS guidance. Many taxpayers have conservatively reported the income as they earn it (much like interest income). However, this has recently been challenged by Joshua Jarrett (Jarrett v. US) who filed an original tax return which reported his staking income in the period which it was earned. Jarrett subsequently filed an amended tax return which excluded the staking rewards from his income on the basis that the staking rewards should be treated as “creation of property” which would defer the recognition of income until the staked coins are sold or exchanged. The IRS has issued a refund to the taxpayer but they have not explicitly confirmed staking rewards follow the same rules as created property. Taxpayers should consult with their tax advisor on how to treat this activity.
Cryptocurrency Airdrops ARE a taxable event
Cryptocurrency airdrops aren’t entirely free as the IRS specified that new coins received through an airdrop are taxed as ordinary income. The amount of income is the fair market value of the coin at the time you have dominion and control of the asset. They are not subject to self-employment tax and the amount you recognize as income becomes your basis in the airdropped coins.
Trading one cryptocurrency for another IS a taxable event
If you’re trading between cryptocurrencies, a gain or loss will need to be recognized when you file your income taxes. Here’s an example of how fictional investor Tom would need to recognize his gain after trading between BitCoin (BTC) and Ethereum (ETH):
- Tom purchased 1Bitcoin for $10,000 on September 13, 2021
- Market went up, so 1 BTC is now worth $20,000 on October 13, 2021
- At the same time, Ethereum went down in price, so Tom sees a great buying opportunity. He purchased 20 Ethereum using a fraction of the BTC he previously purchased. 1 ETH = $400
- First, Tom needs to calculate the value of the new property – the Ethereum. Remember, cryptocurrency is treated as property for tax purposes. In this case, Tom’s new property is 20 ETH units worth $8,000 (20 X $400)
- Next, Tom needs to calculate the value of the property, the BTC, he spent to get the new ETH. Tom spent $8,000 of the $20,000 he had in BTC, getting us to 0.4
- Finally, Tom calculates that gain/loss he experienced from disposing of 0.4 BTC. His cost basis of the BTC he sold was purchased at $10,000 x 0.4 = $4,000. Since the BTC gained value at the time he purchased the ETH, the proceeds of the BTC sold is $20,000 x 0.4 = $8,000
- Subtracting $4,000 from $8,000 leaves Tom with $4,000 that needs to be reported on a Form Schedule D because it is subject to capital gains tax
Buying and selling NFTs are OFTEN taxable events
NFTs are digital assets that are available primarily on the Etherum blockchain, but other blockchains are entering the NFT space as well. Whatever blockchain an NFT resides on is generally the type of cryptocurrency necessary to purchase it. It is important to note that if the crypto you used to purchase an NFT has increased or decreased in value prior to purchasing the NFT, you will recognize a gain or loss as you would exchanging one cryptocurrency for another.
Selling an NFT, however, is a taxable event. You’ll take your sale price, subtract your basis (including any fees) and see if you’re recognizing a gain or a loss. NFTs are likely considered collectibles which carry a higher rate compared to capital gain rates. The top rate for collectibles is 31.8% vs 23.8% for capital gains. If you owned the NFT for less than a year, the sale will be taxed at ordinary income rates.
Gifted Cryptocurrency MIGHT be a taxable event
When you’re gifted cryptocurrency, the same tax laws apply as if you were gifted any other type of property: With any gift, if the gift exceeds $15,000 then a gift return must be filed.
The event of you receiving the crypto as a gift is not a taxable event. Your basis in virtual currency received as a bona fide gift differs depending on whether you will have a gain or a loss when you sell or dispose of it. For purposes of determining whether you have a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift. For purposes of determining whether you have a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift. If you do not have any documentation to substantiate the donor’s basis, then your basis is zero.
Your holding period in virtual currency received as a gift includes the time that the virtual currency was held by the person from whom you received the gift. However, if you do not have documentation substantiating that person’s holding period, then your holding period begins the day after you receive the gift.
Charitable Cryptocurrency Gifts is NOT a taxable event
If you donate virtual currency to a charitable organization described in Internal Revenue Code Section 170(c), you will not recognize income, gain, or loss from the donation, so it is not a taxable event.
You are also able to claim a charitable contribution deduction when you donate cryptocurrency. Your charitable contribution deduction is generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year. If you have held the virtual currency for one year or less at the time of the donation, your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution.
If you’re a charitable organization accepting cryptocurrency donations, you can assist a donor by providing the contemporaneous written acknowledgment that the donor must obtain if claiming a deduction of $250 or more for the virtual currency donation. A charitable organization is generally required to sign the donor’s Form 8283, Noncash Charitable Contributions, acknowledging receipt of charitable deduction property if the donor is claiming a deduction of more than $5,000 and if the donor presents the Form 8283 to the organization for signature to substantiate the tax deduction. The signature of the donee on Form 8283 does not represent concurrence in the appraised value of the contributed property. The signature represents acknowledgement of receipt of the property described in Form 8283 on the date specified and that the donee understands the information reporting requirements imposed by section 6050L on dispositions of the donated property
Corrigan Krause Can Help
Investing in cryptocurrency and NFTs can be exciting, but it’s important to make sure you’re documenting your activity properly so you’re ready come tax season. Email firstname.lastname@example.org to connect with one of our cryptocurrency experts for more information.