The purpose of this article is to inform readers about cryptocurrency as it relates to income taxes. This is NOT investment advice. If you would like to learn more about cryptocurrency, I would encourage you to do your own research. Cryptocurrency is what could be referred to as an emerging asset class, its viability long term is anything but definite. It is subject to risks you would commonly associate with securities as well as cyber threats and additional regulatory risks.
The following article provides some basic information:
https://www.nerdwallet.com/article/investing/cryptocurrency-7-things-to-know
Starting in 2020 the form 1040 (Individual Tax Return) included the question:
“At any time in 2020, did the taxpayer receive, sell, send, exchange or acquire any financial interest in any virtual currency?
The inclusion of the question on the 1040 sends a clear message that the IRS is taking cryptocurrency reporting seriously. They are also taking the enforcement of reporting gains and losses from cryptocurrency seriously.
The IRS gave further guidance on March 2, 2021 by updating their FAQ to include:
“If your only transactions involving virtual currency during 2020 were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question
Cryptocurrency sales are reported on the form 1040 Schedule D.
Information that is needed to properly report crypto sales include: Date of Purchase, Date of Sale, Cost Basis, and Sales Price.
Currently cryptocurrency is not subject to the “wash rules” like stocks, however there is a push from regulators to make crypto subject to this rule. If this rule changes the taxpayer would also be responsible for tracking wash sales.
The new infrastructure bill was signed into law recently which puts a requirement on crypto exchanges to report sales via a form 1099-B just like stock exchanges. The 1099’s produced by exchanges may be very inaccurate in their reporting of basis and this is at no fault or control of the exchanges.
The only time these forms can be accurate in regards to basis is when the taxpayer transfers fiat currency (Government issued currency) to the exchange, purchases their crypto on the exchange, holds and ultimately sells it on the exchange. This would be the normal life cycle for example stocks purchased on an exchange but this is not typical for cryptocurrency.
Cryptocurrency is sent from exchange to exchange, wallet to wallet easily and without assistance from a broker. Much like fiat currency sent via services like zelle. An exchange can know if you sold the cryptocurrency on their exchange but if it was transferred in there would be no way of them knowing the original basis. Cryptocurrency is highly volatile and this could cause a huge discrepancy in what is reported as your basis on the 1099 and the original basis. Tracking your own basis and utilizing software which tracks your basis between exchanges and wallets is more important now than ever before.
Some exchanges may not be able to meet the requirements of the new law and will either have to change, close service to the United States or continue illegally. As these may be foreign entities without clear origins or ownership, enforcement may be impossible. These exchanges are decentralized, they are comprised of software and enable individuals to trade on their platform. These exchanges do not collect personal information and are incapable of meeting the requirements of the new law without major changes. The result as argued by several congressman is that this law will stifle innovation and push economic opportunities and/or access overseas. This legislation does not go into effect until January 1st 2023 so there is plenty of time for amendment.
It is very important to remember that not all Crypto Services provide assistance in tracking your cost basis and those that do charge for this service. There are also services which will track your basis across several services (wallets). The burden of tracking the information necessary to self-report is the responsibility of the taxpayer. Anyone who invests in cryptocurrency should do their own research.
To put this into real dollars. If you are using multiple services, purchased bitcoin for $45,000, transferred it to your other service after a drop to $35,000 and then eventually sold it for 42,000.
In reality you suffered a $3,000 capital loss, the 1099B from the second service may show a $7,000 gain if it considered your transfer in price (35,000) as the basis. If it did not, the second service may report a gain of $42,000 with your basis not being reported.
Without proper records the IRS may interpret the information in a light that benefits them the most.
The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities, asset or other financial instruments in this or in in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.
