Crypto Taxes and Accounting

What Are the IRS Crypto Tax Guidelines? Here’s Your Complete IRS Cryptocurrency Tax Guidance Guide!

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September 21, 2021
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    Cryptocurrencies have become a popular asset for both short-term traders and long-term investors, as well as cryptocurrency enthusiasts. The combination of overnight millionaires, fraudulent initial coin offerings and the involvement of institutional investors has led regulators to clamp down — from the IRS to the SEC to the CTFC.

    Let's take a closer look at the IRS' cryptocurrency guidelines and how they might evolve in 2021 and beyond.

    What's the Official IRS Cryptocurrency Tax Guidance?

    The IRS provided initial guidance for cryptocurrencies back in 2014, saying that they would be treated as property. Unlike fiat currency, the agency made it clear that cryptocurrency holders must calculate and pay taxes on capital gains arising from any transactions. These capital gains or losses must be reported on Form 1040 Schedule D and/or Form 8949.

    The highlights from the IRS cryptocurrency guidance include:

    • Cryptocurrency held for one year or less before selling or exchanging will have a short-term capital gain or loss that’s subject to ordinary income tax. If you held the cryptocurrency for more than one year, then you have a long-term capital gain or loss that’s subject to the capital gain tax rate.
    • Income received as payment for a product or service is still subject to capital gains or losses as property — it’s never treated as a currency. The cost basis is the price at which the cryptocurrency traded when you received it, in U.S. dollars.
    • Cryptocurrency received from an airdrop following a hard fork is subject to ordinary income equal to the fair market value of the new cryptocurrency when it’s received, which is when the transaction was recorded on the distributed ledger, provided that you have dominion and control over the cryptocurrency.
    • Cryptocurrency miners must report any income from their activities as ordinary income at the time it’s mined, as well as pay capital gains taxes on the cryptocurrency when they exchange it for fiat or other cryptocurrencies.

    Over the ensuing years, Congress members sent several letters to the IRS seeking clarity on these regulations. The IRS finally responded to an April 2019 letter requesting guidance on methods to calculate cost basis and the tax treatment of forks.  The brief Q&A response answered some questions, but opened the door to many more questions about the same issues.

    Congress sent another letter to the IRS on December 20 seeking further clarification on the tax treatment of forks and airdrops. In particular, there was concern over the fact that people may be responsible for paying tax on a fork or airdrop even if they weren't aware of it. There's also a lack of IRS cryptocurrency guidance on futures trading, earned interest, and income.

    Until the IRS responds with further guidance, cryptocurrency holders should continue to aggregate their transactions, calculate the gain or loss and report those figures on their tax returns to the best of their abilities. ZenLedger helps simplify the process by automatically calculating the cost basis for each transaction and handling unique events.

    What Could Change in 2021?

    There are many different cryptocurrency bills making their way through the House of Representatives and the Senate. While many of them are dead-on-arrival, there are some that could dramatically reshape the cryptocurrency landscape. Investors should keep an eye on these bills in order to prepare for any changes and avoid any potential issues.

    The Virtual Currency Tax Fairness Act of 2020 is perhaps the most substantial change on the horizon. The bill would provide an exemption for virtual currency expenditures that qualify as personal transactions. Consumers wouldn't have to report instances when they spent crypto that's value changed relative to the U.S. dollar on day-to-day expenses, like buying a coffee.

    Other substantial bills include:

    • The Blockchain Regulatory Uncertainty Act would exempt blockchain developers and service providers from certain licensing and registration requirements that apply to money transmitters, money services businesses, and other brokers.
    • The Safe Harbor for Taxpayers with Forked Assets Act would establish a safe harbor period to prohibit penalties and additional taxes from applying to a taxpayer who receives a forked convertible virtual currency until the IRS cryptocurrency guidance or issues regulations, or legislation is enacted.

    The IRS is likely to remain aggressive in its efforts to collect taxes on cryptocurrency transactions. After sending tens of thousands of warning letters last year, it's clear that the agency is stepping up its efforts to hold investors that profited from Bitcoin's rise to pay back taxes, although others could benefit from reporting crypto losses.

    5 Interesting Points For Cryptocurrency Investors From The Latest IRS Guidelines!

    Here are 5 interesting facts for crypto investors as per the latest IRS guidelines:

    1) ‍ Hard Forks: if You Got Units of New Crypto, You Have Gross Income

    Revenue Ruling 2019 – 24 covers the tax status and treatment of cryptocurrency hard forks. It defines such terms as “hard fork”, airdrop”, and explains different situations where taxpayers do or do not have gross income as a result of an airdrop following hard work. The rule is pretty simple: if a taxpayer does not receive crypto units as a result of a hard fork, he/she does not have gross income. On the opposite side, if as a result of an airdrop following a hard fork you get units of a new cryptocurrency, you do have gross income.

    2) You Must Recognize Capital Gain or Loss

    FAQs provide additional IRS cryptocurrency guidance and reconfirm that taxpayers must recognize capital gain or loss when selling crypto, also mentioning that a short-term capital gain or loss can be recognized if a taxpayer held the virtual currency for one year or less before selling or exchanging it.

    3) Tax Lots: You Can Choose which Units of Crypto Were Involved in Transactions

    ‍ They also describe the situation where you own multiple units of the same cryptocurrency that you purchased at different times with different basis amounts. It’s interesting that the IRS’s states that in this situation “You may choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if you can specifically identify which unit or units of virtual currency are involved in the transaction and substantiate your basis in those units.”

    The best way to choose them and save on your taxes is to use ZenLedger. With our automatic reports, you can identify the cost basis or value of your crypto when purchased and sold, and thus choose the best option.

    4) Transfers are not Taxable Events

    The IRS also elaborates on transfers of cryptocurrency and confirms that “If you transfer virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you” the transfer is not considered as a taxable event. This is very good news for crypto holders because some exchanges including Coinbase count withdrawals as taxable events, which means that now you can refile your taxes for the previous years and ask for a refund (ask us how).

    ‍5) It's Your Responsibility to Maintain Your Records

    Finally, the IRS states that crypto owners must maintain all records including receipts, sales, exchanges, “or other dispositions of virtual currency and the fair market value of the virtual currency.”

    Using a tax tool like ZenLedger will help you maintain this information and make it an easy task.

    Sign up for free now, we have a one-year refund policy – no questions asked.

    Additional resources:

    How to Avoid Crypto Tax Problems

    The IRS is aggressively pursuing cryptocurrency holders, but they haven't issued clear guidance about airdrops or forks.The easiest way to avoid any problems with the IRS is to use cryptocurrency tax preparation software like ZenLedger. ZenLedger automatically aggregates transactions across different exchanges and wallets, calculates the capital gain or loss, and pre-populates Form 1040 Schedule D, Form 8949 and other popular IRS forms to provide your accountant.

    ZenLedger Platform
    Screenshot of the ZenLedger Platform - Source: ZenLedger

    Unlike many competitors, ZenLedger provides a clear and defensible audit trail that can be leveraged in the event of an IRS audit. There's no black box algorithms involved and everything is calculated very transparently for an auditor to verify. If your accountant uses ZenLedger, you can easily share your account details for them to use when preparing taxes.

    ZenLedger even helps reduce your tax burden by automating the tax loss harvesting process. With a few clicks, you can identify opportunities to harvest losses for the tax year and reduce your liability. It's the easiest way to capitalize on cryptocurrency wash sales rules and save money in a way that's both transparent and easy-to-use.

    Finally, it's a good idea to work with an accountant that has experience with cryptocurrencies. In many cases, accountants may find ways to reduce your crypto tax burden by combining strategies with other stocks or bonds in your portfolio. They may also be able to help you navigate evolving tax law and ensure that you're not making any mistakes.

    The Bottom Line

    The cryptocurrency market is experiencing tremendous growth, but along with it, growing pains. While the IRS is aggressively pursuing crypto holders, they have yet to answer some basic questions about how to treat airdrops and forks. Traders and investors should be sure to report their gains or losses properly until further notice.

    IRS Cryptocurrency Tax Guidance FAQs

    1. Do I need to report crypto on taxes?

    The IRS considers virtual currency as taxable property. Meaning, your cryptocurrency will be taxed similar to your other assets such as gold and stocks.

    2. Does the IRS know I have crypto?

    The IRS keeps a record of all the virtual currency transactions that you made. This includes buying as well as selling crypto at profits and considering them as capital-gain tax.

    3. What happens to coins in the case of a hard fork?

    Revenue Ruling 2019 – 24 covers the tax status and treatment of cryptocurrency hard forks. It defines such terms as “hard fork”, airdrop”, and explains different situations where taxpayers do or do not have gross income as a result of an airdrop following hard work. The rule is pretty simple: if a taxpayer does not receive crypto units as a result of a hard fork, he/she does not have gross income. On the opposite side, if as a result of an airdrop following a hard fork you get units of a new cryptocurrency, you do have gross income.
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