How to Report Virtual Currency to the IRS?

By  //  June 17, 2021

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Cryptocurrencies are not currencies or a medium of transaction, legally, in the US according to the IRS. They are considered capital assets. As such, they are taxed for capital gains just like stocks and bonds are.

Cryptocurrencies are not currencies or a medium of transaction, legally, in the US according to the IRS. They are considered capital assets. As such, they are taxed for capital gains just like stocks and bonds are.

Crypto and taxes – What changed over the past few years?

Although the IRS came up with its guidelines for cryptocurrencies during the boom in Bitcoin adoption in the US back in 2014, not many used to file their cryptocurrency profits or income. In the past few years, things have changed.

IRS came up with updated guidance for cryptocurrency users and traders in 2019. You can learn more on the IRS virtual currency FAQs page.

IRS has been imposing the guidelines more strictly and consequently, a lot more people are now filing their cryptocurrency profits and income.

Things like not reporting your cryptocurrency profits haven’t become more punishing. The only thing that’s changed in the past few years is the awareness surrounding it.

More and more people now know that:

■ Cryptocurrency income, as well as mining rewards, are to be considered ordinary income and filed alongside your normal tax returns as income.

■ Profits made out of buying and selling cryptocurrencies on the crypto exchange is taxable and depending on whether or not it’s a short-term (less than a year) gain or long-term (more than a year) and how you’re filing (individually, as a married couple, and so on), it can range from 0% to 37%.

A large number of people are now paying taxes on their cryptocurrency-based capital gains. For example, if someone owned Bitcoin a year ago when it was around $5,000 and held it for over a year, such that it now values at $36,000, the profit they made will be taxed. Note that you need to keep the documents or receipts of your purchase handy otherwise you might be taxed on your total holdings and not just the profit made.

How will IRS know if you are a crypto trader?

Cryptocurrencies are privacy-friendly. As such, transacting on the blockchain of a cryptocurrency is an anonymous thing. However, the exchanges investors and traders use to convert their fiat money to cryptocurrencies are not anonymous. In fact, some of them even have excruciating and in-depth KYC registrations.  For example, Redot crypto exchange has strong KYC policy although they don’t yet serve US crypto investors.

One of the most popular exchanges, Coinbase, was ordered by the IRS in late 2016 to hand over the transactional information on upwards of 14,000 customers who were supposedly involved in buying, selling, receiving, trading, investing in, or sending a total of nearly $20,000 worth of Bitcoin between 2013 and 2015.

In early 2018, Coinbase disclosed the details of close to 13,000 users.

This had sent an undercurrent of panic to cryptocurrency investors and traders who were largely unaware of taxation policies in terms of cryptocurrency holdings.

Back in 2018, less than a hundred people out of the 250,000 who filed tax returns reported cryptocurrency gains. This was clearly an issue of under-reporting cryptocurrency profits.

The IRS (or anyone else) cannot track who sent cryptocurrency to whom just by seeing a transaction (all transactions are open for cryptocurrencies, including Bitcoin, and they can be seen on tools called “blockchain explorers”). They can, however, get information from exchange companies such as Coinbase and find out who has been investing in cryptocurrencies and how much.

Do you owe something if you sold your crypto a few years ago?

Every cryptocurrency transaction done by Americans is taxable. For example, if you paid for coffee or received payment for a service using cryptocurrencies, it’s taxable. If you purchased or sold cryptocurrencies and made a profit, it’s also taxable.

Whether you sold it a few years ago or just recently, it doesn’t matter. Your transactions are taxable.

How to properly report crypto income

It’s solely your responsibility to track your cryptocurrency income and trading profits. Here are the details that you need to track as a prerequisite:

1. When did you purchase, transact, and sell?

2. What were the USD-equivalent values of these transactions?

3. Calculation of how much profit or loss was made in these transactions.

Most exchanges and the blockchain itself provide timestamps and USD-equivalent values. So, finding and compiling this information is not very difficult.

Once you have these prerequisites under the belt, you now need to report your profits or gains (in the case of cryptocurrency investments or trading) and the income (in the case of receiving payments for products and services for cryptocurrencies and any cryptocurrency mining rewards).

This can be done by filling the relevant columns (income and capital gain) in Schedule D, an attachment of the form 1040.

Do you have to pay taxes on airdrops and forks?

Yes. Airdrops and hard fork drops are taxable as income.

Let’s first understand what are these things.

■ An airdrop is an official cryptocurrency giveaway. Usually, new cryptocurrencies market themselves with a series of tools that might include an airdrop for eligible, a select few people, or early adopters.

■ Blockchains sometimes go through “forks”. There are soft forks and hard forks. Essentially, a blockchain dividing is called a fork. A hard fork is when the entire blockchain is split with a new set of rules, and as a result, we have a new cryptocurrency based on the previous one, but with different rules. For example, Bitcoin was hard forked back in 2017 into Bitcoin Cash (BCH) to offer better transaction speeds and lower transaction fees. When this forked happened, people who followed Bitcoin Cash received the equivalent amount in BCH tokens. This cryptocurrency is also taxable.

In both cases, the USD-equivalent value of the cryptocurrency at the time of you taking ownership of the cryptocurrency (by any means, in either a custodial or noncustodial wallet) will be taxable just as if it were an ordinary income.