Virtual Currency Tax Considerations

Over the past few years, we have seen a significant increase in clients trading virtual currencies such as cryptocurrencies.

Investopedia defines virtual currencies as follows:

“A virtual currency is a digital representation of value only available in electronic form. It is stored and transacted through designated software, mobile, or computer applications. Transactions involving virtual currencies occur through secure, dedicated networks or over the Internet. They are issued by private parties or groups of developers and are mostly unregulated.  Virtual currencies are a subset of digital currencies and include other types of digital currencies such as cryptocurrencies and tokens issued by private organizations.”

Although taxpayers invest in and trade cryptocurrencies similarly to traditional securities, there are differences taxpayers need to be aware of when trading virtual currencies.

1. Investing in virtual currencies and selling the virtual currency at a later date will result in capital gain or loss treatment for taxes. If the currency is held for more than twelve months the gain or loss will be taxed as a long-term capital gain or loss, and if held twelve months or less the gain or loss will be taxed as a short-term capital gain or loss.
2. Wash sale rules (selling an investment for a loss and buying an identical security within 30 days before or after the sale date) do not apply to virtual currencies. Wash sale rules apply to stocks and securities. IRS Notice 2014-21 states that virtual currencies are treated as property for tax purposes.  Being defined as property and not as stocks or securities, virtual currencies such as crypto are not subject to wash sale rules.
3. Because virtual currencies are not considered a stock or a security, taxpayers cannot claim a capital loss due to “worthlessness” for significant declines in value of the virtual currency. Taxpayers can only claim a capital loss at the time of sale or disposition of the virtual currency.
4. Cryptocurrency received for work performed for a company is considered ordinary income and treated as wages or self-employment income. The crypto income is valued in dollars based upon the crypto’s fair market value on the date the virtual currency is received.
5. If you use your cryptocurrency to buy an item, that transaction will result in a reportable sale of your crypto.
6. Although some brokerage firms track their investors’ crypto transactions and issue a 1099-B at year end to report the transactions, such reporting is not currently required. Whether or not you receive a 1099-B, the crypto sales are still required to be reported on your tax return.  Therefore, taxpayers will need to track the purchases and sales of crypto transactions on their own in the case that they will not be receiving a 1099-B from the investment firms they are trading through.