The IRS will ask every taxpayer about cryptotransactions this tax season – here’s how to report them

The IRS will ask every taxpayer about cryptotransactions this tax season - here's how to report them

The 2021 version of IRS Form 1040 asks if at any time during the year you received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. If you did, you are supposed to check the “Yes” box. The fact that this question appears on page 1 of Form 1040, right below the lines for supplying basic information like your name and address, indicates that the IRS is serious about enforcing compliance with the applicable tax rules. Fair warning.

Story Highlights:

  • Understand this: the IRS wants to know about your crypto transactions

  • When to check the ‘Yes’ box on crypto transactions

The 2021 Form 1040 instructions clarify that virtual currency transactions for which you should check the “Yes” box include but are not limited to: (1) the receipt of virtual currency as payment for goods or services that you provided; (2) the receipt or transfer of virtual currency for free that does not qualify as a bona fide gift under the federal tax rules; (3) the receipt of new virtual currency as a result of mining and staking activities; (4) the receipt of virtual currency as a result of a hard fork; (5) an exchange of virtual currency for property, goods, or services; (6) an exchange/trade of virtual currency for another virtual currency; (7) a sale of virtual currency; and (8) any other disposition of a financial interest in virtual currency.

If in 2021 you received any virtual currency as compensation for services, check the “Yes” box and report the income the same way as you would report other income of the same nature. See Example 3 below.

If in 2021 you disposed of any virtual currency that was held as a capital asset through a sale, exchange, or transfer, check the “Yes” box and use familiar IRS Form 8949 and Schedule D of Form 1040 to figure your capital gain or loss. See Examples 1 and 4 below.

When to check the ‘No’ box on crypto transactions

You cannot leave the virtual currency transaction question unanswered. You must check either the “Yes” box or the “No” box. 

A transaction involving virtual currency does not include holding virtual currency in a wallet or account, or the transfer of virtual currency from one wallet or account that you own or control to another that you own or control. If that’s all that happened last year, check the “No” box. Also check the “No” box if your only virtual currency transactions in 2021 were purchases of virtual currency for real currency, including the use of real currency electronic platforms such as PayPal

Key point: For more information on the federal tax treatment of virtual currency transactions, see these FAQs on the IRS website.   How to report crypto gains and losses on your 2021 Form 1040

Now for the meat of this column. Despite what the IRS says, let’s use the term cryptocurrency instead of virtual currency. Onward.  The IRS takes the position that cryptocurrency is “property” for federal income tax purposes. (Source: IRS Notice 2014-21.) That means you’re supposed to recognize and report taxable gain or loss whenever you exchange cryptocurrency for U.S. dollars, Euros, goods or services, real estate, a new Tesla, a different cryptocurrency, or whatever.  

The current values of the most-popular cryptocurrencies are listed on exchanges, and I hope you kept track of what you did last year. For example, Bitcoin and a bevy of other cryptocurrencies are listed on the Coinbase
exchange. If you sold one bitcoin on 9/5/21, you should have received about $51,750, according to the Coinbase exchange. You might have actually received a little more or a little less. If you bought one bitcoin with U.S. dollars on 9/5/21, you should have paid about $51,750. You might have actually paid a little more or a little less. Your basis in the bitcoin for federal income tax purposes would be whatever you paid.  * You’ll have a tax gain if the FMV of what you receive in exchange for a cryptocurrency holding exceeds your tax basis in the cryptocurrency that you exchanged. 

To arrive at the federal income tax results of a cryptocurrency transaction, the first step is to calculate the fair market value (FMV), measured in U.S. dollars, of the cryptocurrency on the date you received it or paid it.  If you fail to report cryptocurrency transactions on your Form 1040 and get audited, you could face interest and penalties and even criminal prosecution in extreme cases. 

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