With the tax deadline just a few weeks ago—Tax Day is April 18—taxpayers are scrambling to finish and file their returns. One thing that may be causing some confusion this year? Cryptocurrency. While it’s not a new tax topic, conflicting advice about losses and different wording on Form 1040 are resulting in some head-scratching. Here are five things you need to know about cryptocurrency before you file your tax return.
Check The Box
The IRS is getting serious about cryptocurrency—er, digital assets. This year, the question near the top of your Form 1040 asks, “At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
According to the IRS, “digital assets are any digital representations of value that are recorded on a cryptographically secured distributed ledger or any similar technology.” That includes non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins.
And just in case there’s any confusion, the IRS notes that “if a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.” In other words, if it looks like a duck, walks like a duck, and quacks like a duck, it may just be a duck.
Not every digital asset transaction requires you to tick the yes box. For example, just holding a digital asset in a wallet or account, or transferring a digital asset from one wallet or account you own or control to another wallet or account that you own or control doesn’t result in a yes. It also doesn’t include the purchase of digital assets using cash or other currency, including through the use of electronic platforms like PayPal
Do not leave the question unanswered. All taxpayers must tick a box, not just those who engaged in a transaction involving digital assets in 2022.
Income Is Income
This is true no matter what the income looks like once it gets to you. That means the receipt of cryptocurrency or other digital assets in exchange for services is considered income. That includes income earned as an employee or as an independent contractor.
Income may also be recognized from mining and staking. And if a hard fork is followed by an airdrop and you receive new cryptocurrency, the IRS considers that to be taxable income.
But not all transactions result in the recognition of income. If your cryptocurrency went through a hard fork, and you did not receive any new cryptocurrency, you don’t have taxable income to report. Similarly, a soft fork will not result in any taxable income.
Cryptocurrency Is Property
The IRS considers cryptocurrency a capital asset. The agency issued guidance in 2014, making it clear that capital gains rules apply to any gains or losses.
- If you buy and sell cryptocurrency as an investment, you’ll calculate gains and losses the same way you buy and sell stock.
- If you treat cryptocurrency like cash—spending it directly for goods or services, or using it to buy other digital assets—the individual transactions may result in a gain or a loss.
For tax purposes, you figure your capital gains or losses by determining how much your basis—typically, the cost you pay for assets—has gone up or down from the time that you acquired the asset until there’s a taxable event. A taxable event can include a sale, gift, or other disposition.
If you hold an asset for more than one year before a taxable event, it’s considered a long-term gain or loss. And if you hold an asset for one year or less before a taxable event, it’s considered a short-term gain or loss.
And while cryptocurrency goes up and down, you care the most about the beginning and the end—what happens in the middle doesn’t really count. That’s because, for tax purposes, when cryptocurrency takes a dive, that doesn’t equal a realized loss. Similarly, when it goes back up in value, that doesn’t equal a realized gain. To realize a gain or a loss for tax purposes, you must do something with the asset, like sell or otherwise dispose of it.
At tax time, you’ll report any realized gains and losses on Schedule D. You don’t need to file a Schedule D if you don’t have any realized gains or losses—even if the value changes, if there’s no sale or disposition, there’s nothing to report.
Losses May Be Limited
Like other capital assets, if any realized losses from digital assets exceed any realized gains, you have a capital loss. You can claim up to $3,000 (or $1,500 if you are married filing separately) of capital losses in a tax year—the amount of your loss offsets your taxable income. However, if your losses exceed those limits, you can carry them forward to later years, subject to certain limitations and restrictions.
Here’s how that works. Let’s say that you realized $3,500 in net capital losses in 2022. You can deduct $3,000 in capital losses for the 2022 tax year—the return you’re filing now—and carry forward the remaining $500 in losses to use on next year’s tax return.
Something Isn’t Nothing
There’s been a lot of speculation about how to treat cryptocurrency that has declined quickly in value to the point of almost being worthless. Specifically, it’s been suggested that if your cryptocurrency has substantially dropped in value, you can claim it as a loss under section 165.
In January, the IRS Office of Chief Counsel issued Memorandum 202302011. The “non-taxpayer specific advice” confirmed two things:
- If you lose most of the value of your cryptocurrency, it’s not worthless—it still has value. That means that you don’t have a sustained loss under section 165.
- Even if you sustained an actual loss under section 165, the loss would be disallowed because section 67(g) suspends miscellaneous itemized deductions for taxable years 2018 through 2025 (some exceptions apply).
The memorandum references Lakewood Assocs. v. Commissioner, 109 T.C. 450, 459 (1997), claiming, “The mere diminution in value of property does not create a deductible loss.” In other words, if it’s not wholly worthless, you still own something and there’s no realized loss.
It’s worth re-emphasizing that the IRS memo is a response to a “request for non-taxpayer specific advice,” which means that it “should not be used or cited as precedent.” It doesn’t carry the same weight as a law or regulation. However, it does offer insight into how the IRS regards an issue, and that’s valuable information.
This is a quick look at some of the most common cryptocurrency questions—there are certainly some more complicated cryptocurrency scenarios not addressed here.
If you’re seeking more information, the IRS has some links and FAQs specific to digital assets on its website. And while the internet can offer some useful advice (hey, you’re reading this right now), not all cryptocurrency tax advice is created equal. If you have questions, I highly recommend consulting with a knowledgeable tax professional.