In recent years, the IRS has been expanding their efforts to address noncompliance related to virtual currency transactions. These efforts have ranged from education to audits and criminal investigations. It is now more important than ever for taxpayers to understand their tax obligations regarding virtual currency.
The IRS defines virtual currency as a digital representation of value, other than a representation of the U.S. dollar or a foreign currency, that functions as a unit of account, a store of value, or a medium of exchange. This includes digital currency and cryptocurrency such as Bitcoin, Ethereum, and even Dogecoin.
In general, virtual currency is treated as property for income tax purposes. A taxpayer’s gain or loss will typically be the difference between what the property cost them to acquire and the amount they received in exchange for it. The purchase of virtual currency with U.S. dollars or foreign currency is not a taxable event, but sales and other transactions are taxable. Some common transactions which could give rise to taxable income include:
- The receipt of virtual currency as payment for goods or services;
- The receipt of virtual currency for free that does not qualify as a bona fide gift;
- The receipt of new virtual currency as a result of mining and staking activities;
- The receipt of virtual currency as a result of a hard fork;
- An exchange of virtual currency for property, goods, or services;
- An exchange/trade of virtual currency for another virtual currency;
- A sale of virtual currency; and
- Any other disposition of a financial interest in virtual currency.
Form 1040 asks taxpayers if they have engaged in virtual currency transactions during the tax year. If the taxpayer only purchased virtual currency with U.S. dollars or foreign currency, they may answer no to this question. However, if they have engaged in any of the transactions listed above, they must answer yes to the Form 1040 question. Answering the Form 1040 question incorrectly may subject your return to increase IRS scrutiny. Overall, the IRS is looking for these transactions, making it very important you report properly.
