How to Report Cryptocurrency on Taxes

August 11, 2022 by Jean Lee Scherkey, EA
Cryptocurrency Coin on 1040 Tax Return

As summer quickly approaches, childhood memories of lazy summer days bicycling to the local corner convenience store come to mind. Stepping into the convenience store, some kids went straight to the Slurpee machine, while others wandered the aisles looking for their favorite candy bar, chips, or nuts. As for me, I went for Pop Rocks candy. Come to think of it, cryptocurrency and Pop Rocks have a lot in common – they’re exciting, intriguing, and full of variety. With the endless hours of isolation the pandemic provided, millions of people took this time to experiment with cryptocurrency. Some folks took a few hundred dollars and bought bitcoin on a cryptocurrency exchange like Coinbase or invested in a Bored Ape Yacht Club NFT. Others went all in and immersed themselves in mining and staking activities, delved into crypto lending, or requested their employers to issue their wages in crypto.

cryptocurrency coin and 2 bags of pop rocksAs tax time approached and the hour to pay the piper drew nigh, taxpayers were confused about how to report their cryptocurrency transactions. They might not have wanted to admit their robust fears of losing all their money in some crypto vortex. Similar to cryptocurrency, Pop Rocks had its own mystique and fears. What 1980s kid doesn't remember being double-dogged-dared to wash down a handful of Pop Rocks with an ice-cold cola?

Despite going mainstream, the ins and outs of cryptocurrency transactions remain mysterious (and a bit scary) to both crypto dabblers and self-proclaimed experts. It is so mysterious that some taxpayers may not have known how to address their cryptocurrency transactions on their 2021 individual income tax return. The good news is it's not too late to properly report your 2021 cryptocurrency transactions, even if you threw caution to the wind and entered your cryptocurrency activities with the same skill and determination you use when playing Cornhole blindfolded. For those who put their return on extension, hoping that divine inspiration would strike before October 15 and you would know how to report your cryptocurrency transactions, this is your lucky day too!

Before we tackle how to report four taxable cryptocurrency transactions, allow me to reveal the shortlist of cryptocurrency activities that are considered nontaxable:
 

  • Purchasing cryptocurrency with cash and holding it.  
  • Transferring the same cryptocurrency you own between different wallets you own. (This is similar to transferring money you have from one bank account in your name to another.)
  • Transferring the same cryptocurrency between different exchanges without exchanging it for another cryptocurrency or money.
  • Receiving cryptocurrency as a gift and holding onto it. A reportable transaction happens when cryptocurrency is exchanged for cash, another type of cryptocurrency, an NFT, or other goods and services.

As we discuss the reportable transactions below, remember that cryptocurrency is not treated as money for U.S. federal income tax purposes. Cryptocurrency is treated as property. This means that all the tax rules that apply to property transactions will apply to cryptocurrency transactions. For your reading pleasure, we have a blog explaining the impact of cryptocurrency being treated as property for tax purposes.

The holding period for cryptocurrency (the time an individual keeps a cryptocurrency) starts the day after the cryptocurrency is purchased or otherwise received and ends on the day it is sold or exchanged. The net gain of cryptocurrency held for exactly one year or less (considered a short-term loss) will be taxed at the taxpayer's ordinary tax rate. For 2021, long-term gain income is taxed at a special lower rate determined by the taxpayer's filing status and taxable income.

When purchasing or exchanging cryptocurrency for another cryptocurrency, cash, or goods or services, the fees for acquiring the cryptocurrency are added to the basis of the cryptocurrency received. Likewise, fees paid to exchange cryptocurrency for money, another cryptocurrency, or a good or service are added to the exchange price.

 
  • Exchanging (selling) cryptocurrency for cash: When a person decides to take the cryptocurrency they are holding, whether it be bitcoin, ether, dogecoin, etc., and "cash it in" (exchange it for cash or any other fiat such as the euro, British pound, Canadian dollar, or Japanese yen), the transaction is generally reported on Form 8949, Sales and Other Dispositions of Capital Assets and Schedule D, Capital Gains and Losses, just like a sale of stock is reported. The cost or basis will be the cryptocurrency's fair market value as of the date and time the cryptocurrency was received, and the proceeds or sales price will be the amount of cash or other currency received.

    Here is an example: (In this example, assume the transaction fees are already included in the calculations.)

"A new year deserves a new adventure," Lucy exclaimed as she hopped out of bed and skipped towards her laptop on the desk. On Monday, January 4, 2021, Lucy purchased $500 worth of bitcoin, equaling 0.01612 BTC. On December 1, 2021, Lucy decided to cash in her investment and sold her 0.01612 BTC. When Lucy sold her bitcoin, the price of 1 BTC was $56,000, so her 0.01612 BTC was worth $903, rounded up to the nearest dollar (0.01612 BTC x $56,000 = $903). Since Lucy owned the bitcoin for less than one year, she reported a short-term gain totaling $403 on her 2021 Form 8949 and Schedule D (sales price: $903 – purchase price: $500 = $403). The short-term gain income was taxed at Lucy's ordinary tax rate.

 

  • Exchanging (purchasing) one type of cryptocurrency for another type: Some altcoins (n altcoin is a type of cryptocurrency that is not bitcoin) cannot be directly exchanged (purchased) with money because they are not convertible. Altcoins that are convertible may be exchanged (purchased or sold) with money. Examples of convertible cryptocurrencies are bitcoin (BTC), tether (USDT), and ether (ETH). Generally, for individual taxpayers, cryptocurrency that is exchanged (purchased or sold) for another cryptocurrency is reportable on Form 8949 and Schedule D. Any transaction fees paid when acquiring a cryptocurrency are added to the cryptocurrency's basis. Transactions fees paid when exchanging one cryptocurrency for another are added to the selling price.

    Here is an example:

On December 10, 2020, Mary Jane found a sweet pair of flats embossed with gold and diamonds on Etsy for .25 ether (ETH) (valued at $1,000), and the seller only accepted ether. Mary Jane did not hold ether but held 1,000 units of tether (USDT). On February 9, 2019, she paid $1,000 plus a transaction fee of $20 for the 1,000 units of tether she held, making her total basis in the 1,000 units of tether to be $1,020. Needing these shoes for the Enchanted New Year's Ball, Mary Jane exchanged the 1,000 USDT she held on December 10, 2020 (valued at $1,000 at the time of exchange) for .25 ETH on SushiSwap, a decentralized cryptocurrency exchange. She paid 0.01 ETH ($10) in gas fees to facilitate the transaction. (Gas fees are the name of the transaction fees incurred on the Ethereum blockchain.)  Mary Jane's cost basis in the .25 ETH is $1,010. Since Mary Jane originally purchased the 1,000 USDT over a year ago, she would have a long-term loss of $10, which would be reported on Form 8949 and Schedule D, calculated as follows: $1,010 (selling price) - $1,020 (cost basis of 1,000 USDT) = ($10)

 
  • Buying and selling nonfungible tokens: Trading nonfungible tokens, referred to as NFTs, became all the rage in 2021. According to a report from Nonfungible.com, trading in NFTs reached $17.6 billion in 2021. A nonfungible token represents the ownership of a virtual collectible (like artwork, sports and pop-culture memorabilia, and event tickets) that is unique and cannot be interchanged. Like other tokens, nearly all NFTs are created on top of the Ethereum blockchain. Most NFTs are acquired by exchanging ether (ETH), the native currency of the Ethereum blockchain, or other cryptocurrencies. Because NFTs are attained by exchanging cryptocurrency, buying an NFT is a reportable event and included on the taxpayer's income tax return. 

    Here is an example:

Disappointed that he did not acquire a CryptoKitty NFT when he had the opportunity, Chance resolved not to ignore fate a second time and decided to ride the latest NFT wave by hopping aboard the Bored Ape Yacht Club craze. On June 7, 2021, Chance found the perfect Bored Ape Yacht Club NFT. In the prior year, Chance purchased 3 ETH for $390 on April 1, 2020, and paid $10 in gas (transaction) fees. When he purchased the ether, 1 unit of ether was worth $130. Chance's total basis in the 3 ETH was $400.

On June 7, 2021, Chance acquired the Bored Ape Yacht Club NFT of his eye for $1,500 (.50 ETH). When he purchased the NFT on June 7, 1 ETH was valued at $3,000. Acquiring the NFT is a reportable transaction because Chance relinquished a portion of his ether holdings for the NFT. The gas fee to acquire the NFT was $30. Chance will need to relinquish .51 ETH to acquire the NFT and cover the gas fee.

The gain or loss is calculated by taking the difference between the fair market value of the NFT and the basis of the ether that was exchanged.

 

  • Fair market value of the NFT received was $1,530 ($1,500 + $30 of gas fees = $1,530) 
  • The basis of the .51 ETH used to acquire the NFT was $68 (.51 ETH x $133.33 (the basis of 1 ETH Chance acquired on April 1, 2020: $400 / 3 ETH = $133.33))
  • $1,530 - $68 = $1,462
 

Chance will report a gain of $1,462 on his 2021 Form 1040, Form 8949, and Schedule D. The gain is considered long-term because Chance had held the ether for more than one year. In the future, if Chance decides to sell the NFT, his basis in the NFT is $1,530. If he owns the NFT for less than one year, the gain or loss will be short-term, and if he owns it for over one year, the gain will be long-term. Although the IRS has yet to comment on the tax consequences of selling an NFT, many view an NFT as a collectible, similar to artwork. Generally, gains on collectibles are taxed at a rate of 28%, whether they are held short or long term.

 

 
  • Receiving cryptocurrency rewards for signing up an account on a cryptocurrency exchange or through "Learn and Earn" programs: Many cryptocurrency exchanges, like Coinbase and Crypto.com, reward new account holders with cryptocurrency. Additionally, exchanges like Coinbase and Binance and certain websites like CoinMarketCap offer "learn and earn" programs. Participants generally watch a video in these programs and answer a few questions about the material. For their efforts, they receive cryptocurrency. The cryptocurrency received for opening an account or participating in learn-to-earn programs is considered taxable income as the date and time received. The rewards are considered "other income," and for 2021, reported on Form 1040, Schedule 1, Additional Income and Adjustments to Income, on Part 1, Line 8z. The amount reported as income is the fair market value of the reward as of the date and time it is received. The reported amount will become the cryptocurrency's basis.

    Here is an example:

For turning 30, Felicity gave herself a birthday present by opening an account on Coinbase. For opening the account, $10 in bitcoin (BTC) was dropped into her wallet on July 5, 2021. When the bitcoin was deposited, the fair market value of 1 BTC was $34,200, so $10 worth of bitcoin would equal 0.00029 BTC. ($10 / $34200 = 0.00029 BTC). On August 20, 2021, Felicity took a learn-and-earn module through Coinbase. Once she successfully completed the module, $5 of bitcoin was dropped into her account. When the bitcoin was deposited, the fair market value of 1 BTC was $47,600, so $5 worth of bitcoin would equal 0.00010 BTC ($5 / $47,600 = 0.00010). When Felicity filed her 2021 federal return, she reported $15 of "Coinbase Rewards- 0.0039 bitcoin."



Now, some reading this blog might think, why? Why go through the trouble of reporting small amounts of rewards? No matter how small, these rewards are considered taxable income. While it may be $5 here and $10 or even $20 there, there are multiple ways of earning rewards and given time, these rewards will add up. Additionally, reporting the income from the rewards establishes the basis for these rewards. Cryptocurrency holders will need to have the basis established when the cryptocurrency is subsequently exchanged for another cryptocurrency for cash, goods, or services. Remember, exchanging cryptocurrency rewards is also a reportable transaction and subject to tax.

If all of this information has your head spinning, you are not alone! Even though cryptocurrency has been around for over a decade, taxpayers are still trying to grasp the tax reporting requirements. The landscape of this wild financial frontier is constantly changing, making cryptocurrency exciting and a little scary, just like consuming Pop Rocks with cola when you were a kid. As you had your folks’ safety net to help calm your stomach after eating too much candy, TaxAudit is here for you as you delve into cryptocurrency.

With TaxAudit's prepaid Audit Defense membership, taxpayers are assured that a team of experienced tax professionals will be there if they ever receive a notice from the IRS or state taxing agency about their cryptocurrency transactions or any other area of their federal or state income tax return. Give us a call today. We are here to help!

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Jean Lee Scherkey, EA
Learning Content Developer

 

Jean Lee Scherkey began her career at TaxAudit in 2015, and her current title is Learning Content Developer. She became an Enrolled Agent in 2005. For several years, Jean owned a successful tax practice that specialized in individual, California and trust taxation, and assisting those impacted by tax identity theft. With over fifteen years of varied experience in the field of taxation, Jean has worked at different private tax firms as a Staff Practitioner, Tax Analyst, and Researcher. Before coming to TaxAudit, she worked over two years for TurboTax as an “Ask the Tax Expert.” In addition to her work in TaxAudit’s Learning and Development Department, Jean is actively involved in the company’s ENGAGE Volunteer Program, which provides opportunities for employees to help and serve the local community.  


 

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