As cryptocurrency becomes increasingly common, the IRS is recognizing it as 'property' and formulating tax laws and regulations. Knowing these laws is essential to ensure accurate calculation of tax liabilities. Both topics will be covered next.
IRS Publication 551, known as the Basis of Assets, talks about the value of the taxpayer's investments to evaluate their tax liability. This amount or value is what is known as the basis. Cryptocurrency is classified as a property by the IRS- and not as a currency or security. Thus, the regulations and laws laid as part of the Basis of Assets apply to all cryptocurrencies like Bitcoin, Ethereum, etc.
The taxable cost of a property is its basis. For a cryptocurrency (referred to as virtual currency by the IRS) the cost basis is the amount in US Dollars spent for its acquisition.
This cost basis also includes commissions, fees, and any other costs that may be included in the acquisition of the virtual currency. As per Publication 551, the following costs can be included while calculating the basis:
Testing and installation
Account and legal fees
Real estate taxes
A lot of these may not apply to a cryptocurrency, since Publication 551 deals with all types of property and not just cryptocurrencies.
The cost basis for a cryptocurrency would be the amount paid for its acquisition. This is generally equal to the fair market value of the virtual currency when acquired, at a specific date-time. The time and fair market value of the cryptocurrency on the day it was credited to the taxpayer's account must be recorded.
If the value increases or decreases when the cryptocurrency is sold for cash or exchanged for another virtual currency, there may be additional liability in capital gains/losses. This, again, depends on how it was acquired and the duration for which it was held. The framework is defined in Publication 544 of the IRS,.
Sales And Other Dispositions Of Assets-Publication 544
As the name suggests, Publication 544 (Sales and Other Dispositions of Assets) talks about what happens when any property, including a cryptocurrency, is disposed of. For a cryptocurrency, the specific events that are relevant for Publication 544 include:
Selling cryptocurrency in exchange for US Dollars
Exchanging cryptocurrency for another cryptocurrency
There are 4 things that are relevant for determining the tax basis, which are:
If gain or loss is ordinary capital
Gain or loss in the case where the business property is disposed of
Reporting gain or loss in the tax return
This has already been covered in detail in the earlier section- the difference in the Fair Market Value on the day of acquisition and disposal is the gain (if the value increased) or loss (if the value decreased).
If the cryptocurrency is held for one year or less before exchanging or selling it, it is a short- term capital gain or loss. Otherwise, it falls under long-term capital gains.
The holding period starts from the day the cryptocurrency gets credited into the taxpayer's account, i.e. the day from which they have control to dispose of it (exchange, sell, or use for a purchasing a service/product). This holding period ends the day it is sold/exchanged.
This part deals with cases where the business property is disposed of. (sold/exchanged) Any gains or losses that are made in such transactions are not part of the business schedule in the tax return. Any losses in such scenarios are fully deductible in the year when the sale was made. Gains are considered as ordinary income and additional gain is treated as short- or long-term capital gain depending on the holding period.
IRS Form 8949-D, used for reporting the disposal and sale of capital assets, is where all details of cryptocurrency transactions are to be filled.
Documents: Form 8949
Once the capital gain and loss on all cryptocurrency (or virtual currency) transactions are calculated, Form 8949 (Sales and Dispositions of Capital Assets) is where they are reported. Every transaction involving crypto assets that were made in the reporting year must be included in this form.
The initial information at the top of the form is the first thing to be filled. After that, the taxpayer needs to select either of the 3 checkboxes in Part I of Short-Term Trades. The options being:
A: transactions reported on 1099-B including basis and reported to the IRS
B: transactions reported on 1099-B including basis not reported to the IRS
C: transactions not reported to the taxpayer on 1099-B
is opted by most taxpayers, as crypto-exchanges do not furnish 1099-B. The following information must be provided about each transaction:
- Description/ type of asset - Date of acquisition and selling/disposal - Proceeds (selling value) - Cost Basis - Adjustment to gain or loss - Gain or Loss
The total or aggregate of all transactions would be calculated at the end. These include:
Description/ type of asset
Date of acquisition and selling/disposal
Proceeds (selling value)
Adjustment to gain or loss
Gain or Loss
Same will apply for LONG TERM HOLDINGS on the next page: