Do you own Bitcoin, Ethereum or another type of cryptocurrency? If so, you may have recently received a letter from the IRS. This is the latest effort by the IRS to alert investors about the tax consequences of buying, selling and using digital currencies. The IRS sent out three versions of the letter, all of which you can view on the IRS website.
Here is what you need to know about how the IRS views cryptocurrencies.
How to report cryptocurrency transactions
According to the IRS, virtual currencies like Bitcoin and Ethereum must be treated as an investment in a stock or mutual fund. That means that every time you buy, sell, exchange, or use cryptocurrencies, you will need to recognize a taxable gain or loss on that transaction.
For example, Peter bought one bitcoin when it was worth $1,000. When bitcoin reaches $10,000, he cashes it out. Peter will recognize a capital gain of $9,000 ($10,000 – $1,000). If he held the bitcoin for more than a year, he will have realized a long-term capital gain.
Some businesses also accept bitcoin for payment. For example, Leslie is paid two bitcoins for her web design services. On the day that she receives payment, bitcoin is valued at $5,000. Leslie will recognize business income in the amount of $10,000, which becomes the basis for those bitcoins. A year later, Leslie exchanges those bitcoins for cash, on a day when bitcoin is valued at $12,000. Leslie will recognize capital gain of $14,000 ($24,000 – $10,000).
The IRS has not yet issued definitive guidance on how to determine the basis, but instead recommends choosing a reasonable method and applying it consistently.
Keep detailed records of your transactions
Some cryptocurrency exchanges provide investors with statements that include transaction details, but some do not. Plus, some cryptocurrencies are not listed on any exchanges at all. Therefore, in many cases, you will need to track your purchases, exchanges, and transfers yourself.
Keep in mind that the IRS has not issued guidance regarding minimum reportable transactions. This means you will need to report your gains and losses even for very small transactions.
The IRS Letter
If you did receive a letter from the IRS about your cryptocurrency investments, don’t ignore it. Two of the versions only require a response if you need to report or correct cryptocurrency transactions on your tax returns, but a third version, Letter 6173, requires a response.
Please feel free to contact our offices if you have questions or need help.