Let’s talk Crypto and Taxes
With the rise in popularity of cryptocurrency…
We decided to delve into the taxation of crypto. Virtual currency is treated as property for tax purposes. This includes bitcoin, ether and other forms of similar digital representations of value that act as a substitute for real currency.
Let’s first look at sales or exchanges.
People who sell crypto that they hold for investment will recognize capital gain or loss. That gain or loss is long-term for crypto owned more than 12 months before the sale. Otherwise, it is treated as short-term.
People who sell crypto at a loss needn’t worry about the wash-sale rule.
This rule bars a capital loss write-off if you buy substantially identical securities up to 30 days before or after a sale, with the disallowed loss added to the tax basis of the replacement securities. But the definition of securities for this purpose doesn’t include crypto. So, for example, if you own crypto that sharply falls in value, you can sell it, recognize a capital loss and buy the same digital currency the next day.
If your crypto becomes worthless, you can’t take a worthless securities write-off on your return.
That’s because crypto isn’t a security, so the capital loss write-off for worthless securities isn’t available to individuals who invest in cryptocurrency. IRS recently released a memo on this topic. If you receive crypto for services, you will have ordinary income that you report as wages if employed, or as Schedule C income if you are in business for yourself. The amount of income you report is the crypto’s value in U.S. dollars on the day you receive it, regardless of whether you get a W-2 or 1099 from the payer.
A hard fork of crypto may be taxable.
A fork occurs when there’s a change to the blockchain’s underlying protocol. In a hard fork, those software changes result in a complete blockchain overhaul that causes a split in the cryptocurrency, leading to new crypto. If that new crypto following the hard fork is airdropped or otherwise transferred to you, meaning you receive new crypto units, then there is a taxable event resulting in ordinary income. If, on the other hand, you don’t receive new crypto in an airdrop, etc., then you won’t have income. A soft fork is not a taxable event because it doesn’t result in new crypto.
One open issue is the taxation of staking awards, specifically the timing of when the rewards should be taxed…when they’re created or when they are sold.
This was at the heart of a 2022 court case, in which a couple filed a refund claim alleging that token awards they received through staking are created property that is not taxed on receipt, but instead on disposition. The court tossed the case on procedural grounds without even addressing the substantive tax matter. A 2022 Senate bill would clarify that crypto rewards received through staking are taxed when sold. But that proposal, even if reintroduced in the current Congress, isn’t likely to gain much traction. So it’s up to IRS to issue guidance in the area.