How Does the IRS Handle Taxation of Cryptocurrency?

In some circles, cryptocurrency acts just like a currency. ‘Currency’ here describes the “coin and paper money of the United States or any other country designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance.”

However, the IRS does not recognize cryptocurrency as a currency concerning taxes. Instead, the IRS recognizes it as property.

What is Cryptocurrency?

Cryptocurrency, also known as virtual currency, is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value, according to the IRS website.

Transactions using cryptocurrencies are recorded and verified on a decentralized system using cryptography–a messaging system that allows only the sender and receiver of the message to read it–instead of a centralized authority like a government or bank.

Are Cryptocurrencies Taxed?

Virtual and cryptocurrencies are seen by the IRS as property for general tax principles. A transaction involving crypto or virtual currencies is seen and treated as a transaction involving the trade of property.

Treating virtual and cryptocurrencies as property means that you have recorded a loss if your adjusted basis is more than the amount realized after a transaction. You have recorded a gain if the amount realized is more than the adjusted base.

If the sale of the virtual or cryptocurrency results in real currency, you must recognize any capital gain or loss on the deal, subject to any limitations on the deductibility of capital losses.

When Do I Report Cryptocurrency Trades on My Tax Return?

Buying crypto or virtual currency with real currency and maintaining it within the exchange where you made the purchase, or transferring it to your personal wallet, doesn’t mean you will owe taxes at the end of the year. If you’ve only purchased virtual currency with U.S. dollars, you do not need to report it to the IRS.

The situation has changed if the crypto or virtual currency is used as the method of purchase for a good or service. You will need to report the sale of owned crypto or the virtual currency of U.S. dollars, exchange of one cryptocurrency for another, or paying for goods and services with crypto to the IRS.

Will I Be Audited if My Cryptocurrency Is Not Reported Properly to the IRS?

Bitcoin, Ethereum, and other cryptocurrencies are entirely taxable. The IRS considers the holdings of virtual and cryptocurrency as “property” and treats them like such regarding tax functions. This fact is not altogether unsurprising, as it means the IRS treats virtual or cryptocurrency like any other asset a taxpayer owns, such as stocks or gold.

The buying and selling of crypto and virtual currencies have been an exciting way to invest in the last few years. However, when it isn’t treated right during tax season, it has led to financial ruin for many people. Speak to your local tax professional today and ensure your books are in order. When you’re ready to put yourself in the position to succeed, call us at 786-522-0410 and schedule a consultation.