Cryptocurrency: Tax Status

In 2014, the IRS issued Notice 2014-21 that provided general tax principles that applied to virtual currency transactions. For tax purposes, the IRS treats cryptocurrency as property.

Most people entering the crypto game are entering as an investor. The IRS treats crypto as a capital asset, and tax liability results from any realized gain from sale of exchange (same goes for capital loss). For example, if you buy a Bitcoin on the slump at $40k, and then sell when it hits a high of $60k a few months later, you have a short-term capital gain of $20k. As with typical capital assets like stocks, there is a distinction between short and long term gains, with longer held assets being taxed at a lower rate. Crypto prices can fluctuate wildly even today, so most investors are actively buying and selling with the ebb and flow of the values.

The initial fiat currency exchange for crypto is not a taxable event. Neither is transferring crypto held in one wallet/exchange to another.

Mining creates tax liability too. When a miner receives a transaction fee or is bestowed freshly minted coins for their work, they must include the fair market value of the crypto received as of that day as their realized gross income measured in USD. Fair market values are determined by the exchange rate.

The goal of virtual currency is to use it as a medium of exchange—to use the crypto to pay for goods and services. The IRS has provided some guidance in how to report these types of transactions. If you purchase property with virtual currency, your gain/loss is the difference between fair market value of the property you bought and the value of the crypto you spent.

Most of the time, this should be a 1-1 ratio because prices are cemented at that time by the exchange rates at the time of transaction (hopefully, it means you did not overpay). The reason why buying property with crypto is a slightly risky move at this time is because the rates are cemented as of the time of transaction (e.g., you buy a Tesla (MSRP $50k) with 1 Bitcoin because that is the price and corresponding exchange rate; but the very next day, Bitcoin shoots up to $64k per coin; you just lost $14K).

Hard Forks: a hard fork is when the distributed ledger (blockchain) is changed to a new version and invalidates the older versions of the ledger. Since blockchain and cryptos essentially run using software, hard forks are most often implemented due to new code in the software built for the blockchain. When a hard fork occurs, new crypto tokens are typically issued. The IRS has instructed that if your crypto undergoes a hard fork, and you receive new tokens (airdrop is a term of art that describes the distribution of tokens), you must report the fair market value as income.

Income: If you got paid crypto for goods or services, that is reportable as income based on the fair market value at the time of transaction, in USD.