Cryptocurrency has continued to gain traction and popularity over the last couple of years. Major retailers like Microsoft, Paypal, and Starbucks have also jumped on board and have begun accepting Bitcoin as a form of payment. Naturally, the rise in crypto also brought new tax rules from the IRS, and we are here to help guide you with what it means for your cryptocurrency investments.
Will my cryptocurrency be taxed?
The answer is yes. Last year the IRS added a line towards the top of the 2020 Form 1040 explicitly asking if the individual received, sold, sent, or acquired virtual currency in response to the rise in popularity amongst taxpayers. Cryptocurrency, in general, is taxed as property—capital gains and losses vs. ordinary income. Any cryptocurrency exchange, even for another “coin,” is considered a taxable transaction. The default inventory method for determining gain/loss is FIFO (first in, first out). However, specific identification is allowed if you keep detailed records of the exact item exchanged, including the following:
- The date and time each unit was acquired.
- Your basis and the fair market value of each unit at the time it was acquired.
- The date and time each unit was sold, exchanged, or otherwise disposed of.
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.
What about coins received via an airdrop or hard fork?
Cryptocurrency received via airdrop or hard fork is taxed as ordinary income at the value on the date received. Unsure of what these two terms mean? (Don’t worry, you aren’t alone!)
- Airdrop is a marketing method used by startups where they send you free cryptocurrency, possibly in exchange for promoting awareness of the new virtual currency.
- Hard Fork is changes or upgrades to the blockchain (or database) network resulting in two types of tokens—one following the old rules and another following the new rules.
Are there tax planning opportunities?
- Donations of Cryptocurrency
- If the crypto has been held for more than one year, no capital gain or loss is recognized, and the itemized deduction is in the fair market value on the date of donation. This is a win-win for a taxpayer donating crypto that has appreciated in value.
- If the crypto has been held for less than one year, an itemized deduction is limited to the lesser of cost or fair market value. If the crypto had been received as an Airdrop, your basis is the fair market value on the date it was received.
- Opportunity Zones
- Opportunity Zones are geographical areas spread across the US designated by state and federal governments for economic development. Qualified Opportunity Funds pool together invested funds from individuals to be put directly into development projects in these Opportunity Zones.
- Taxpayers can defer, reduce, or eliminate capital gains tax by investing crypto proceeds, within 180 days of the sale, into businesses and personnel located in Opportunity Zones.
- Cryptocurrency IRA
- Placing crypto into a self-directed cryptocurrency IRA allows for tax-free growth in a Roth IRA or tax-deferred in a traditional IRA.
- Gifts of up to $15,000 per recipient are not subject to the gift tax thanks to the annual exclusion. The recipient will take the donor’s holding period and tax basis, but the fair market value for determining the amount of the gift is established on the date of the gift.
This article was originally published on September 16, 2021 on Eder, Casella & Co.’s Blog.