You know something is on the IRS radar when they actually put a question on the tax return to remind people to report the gains from such transactions. That is what they did with Cryptocurrency. Beginning last year, they asked a question on the first page of Form 1040 to see if a taxpayer sold, sent, exchanged or otherwise acquired any interest in virtual currency.
Virtual currency is something that has really exploded.
- Yes and everything from Bitcoin which a lot of people have heard of to Dogecoin, which was started as a joke and now is taking hold and has gone up 8,100%.
- But like anything that has a market price – joke or not – it is considered to be property and general ta principles apply.
If I remember right, this is taxed at a capital gain, right?
- For the most part yes. Any gains from the purchase and sale of cryptocurrency would be listed as a short or long-term gain or loss. It will be long-term if it is held for one year or more.
- Now for those few that actually mine or create a new virtual currency, that is ordinary income.
Do taxes work like any other sale of a security or stock?
- Yes, if you are simply a buyer and a seller, then your gain is relatively easy to calculate.
- The gain or loss is calculated based on the difference between the price it is purchased for and the price it is sold for.
What if you use virtual currency to purchase items? Is there any tax consequence to this?
- There is actually.
- In this case, you would pay tax on the difference between what you purchased the virtual currency for and the fair market value of what was purchased.
I guess that makes sense, but seems foreign since you don’t normally pay a tax when you buy something?
- That’s right, but normally you are paying for those purchases with a regular currency like cash or credit cards. In this case, what you paid for the cash is the same value as what you are giving up.
- In the case of virtual currency, you bought something for one price and it went up in value before you used it to buy something. This increase in value has enriched you and tax needs to be paid on that enrichment.
What about trading one virtual currency for another type? Would someone need to pay tax on that?
- Yes, because this is what’s called a like-kind exchange.
- And unless it is for real estate, you cannot postpone a gain by buying a property like you used to do.
I am sure that we will talk more about this now that it is becoming mainstream.
- I am sure, but maybe next week we can talk about it from a business’s point of view.
Cryptocurrency can be more complex than a person might think, so it is a good idea to talk to a tax professional.