The U.S. Internal Revenue Service (IRS) has released its first major update in five years to the tax guidelines governing cryptocurrency transactions. This marks a significant step in providing clarity for taxpayers and professionals navigating the evolving digital asset landscape.
Key Updates in the 2019 IRS Guidance
The recent guidance addresses several ambiguous areas from the 2014 policy, offering clearer directives on reporting and compliance.
Cryptocurrency Hard Forks
When a cryptocurrency undergoes a hard fork and you receive new coins, the fair market value of the new assets at the time of receipt is considered taxable income. This value also becomes your cost basis for future calculations.
Example:
If you held 2.5 BTC and received 2.5 BCH from a hard fork when BCH was valued at $500 per coin, you would report $1,250 as income. This amount also sets your cost basis for the BCH.
If no new coins are received during a hard fork, no taxable event occurs.
Cryptocurrency Soft Forks
Soft forks do not create new cryptocurrencies. Thus, they are not considered taxable events.
Cryptocurrency Airdrops
Receiving coins from an airdrop constitutes taxable income based on their fair market value at the time of receipt. If no coins are received, no income is reported.
Cost Basis Calculation Methods
The IRS now formally recognizes two methods for determining cost basis:
Specific Identification: Taxpayers can specify which units of cryptocurrency are being sold, provided they can document:
- Date and time of acquisition
- Cost basis and fair market value at purchase
- Date and time of disposal
- Fair market value and proceeds received at disposal
- First-In, First-Out (FIFO): If adequate records are not maintained to use specific identification, the FIFO method is applied by default. This means the earliest acquired coins are considered sold first.
Non-Taxable Transfers
Moving cryptocurrencies between wallets or exchanges under the same ownership remains a non-taxable event, as no gain or loss is realized.
Overview of U.S. Cryptocurrency Tax Policy
Understanding what triggers a tax event is crucial for compliance.
Taxable Events
- Trading for Fiat: Converting crypto to government currency like USD.
- Crypto-to-Crypto Trades: Exchanging one cryptocurrency for another is taxable. Gain or loss is calculated based on the fair market value in USD at the time of the trade.
- Using Crypto for Goods/Services: Spending crypto is treated as a disposal, triggering capital gains tax.
- Earning as Income: Receiving crypto as payment for services, mining rewards, or other income is taxed at its fair market value upon receipt.
Non-Taxable Events
- Gifting: Giving cryptocurrency as a gift is not a taxable event for the donor (though it may have gift tax implications).
- Transfers Between Wallets: Moving your own crypto from one wallet or exchange to another is not taxable.
- Purchasing with Fiat: Buying cryptocurrency with U.S. dollars does not create a tax liability. The tax obligation arises only when you sell, trade, or spend it.
Special Considerations
- Mining Cryptocurrency: Mining triggers two taxable events. First, the value of the mined coins is taxable as ordinary income at the time they are received. Second, selling those coins later triggers a capital gains tax on any profit. Tax treatment differs for hobbyists versus those mining as a business.
- Capital Losses: If you sell crypto for less than your cost basis, you realize a capital loss. These losses can be used to offset other capital gains and, within limits, other income.
A Step-by-Step Guide to Calculating Your Taxable Gain
Accurately calculating gains or losses is essential for correct tax reporting.
1. Determine Your Cost Basis
Your cost basis is what you paid to acquire the crypto, including the purchase price and any associated costs like transaction fees or commissions.
Formula:Cost Basis per Coin = (Purchase Price + Associated Fees) / Quantity of Coins Acquired
Example:
You invest $100 to buy Litecoin, paying a 1.5% ($1.50) fee, and receive 1.1 LTC.
Your cost basis per LTC is: ($100 + $1.50) / 1.1 = $92.27
2. Calculate Capital Gain or Loss
Subtract your cost basis from the fair market value at the time you sell, trade, or spend the asset.
Formula:Capital Gain/Loss = Fair Market Value at Disposal - Cost Basis
Example:
You later sell one LTC when its price is $200.
Your capital gain is: $200 - $92.27 = $107.73
This $107.73 gain is subject to capital gains tax.
3. Calculating Gains in Crypto-to-Crypto Trades
These trades are taxable. You must calculate the gain in U.S. dollars based on the fair market value of the crypto you disposed of.
Example:
You buy 0.01 BTC for $100 (your cost basis). Later, you trade that 0.01 BTC for LTC. At the moment of the trade, your 0.01 BTC is worth $160.
Your capital gain is: $160 - $100 = $60
This $60 gain is taxable, and your cost basis for the new LTC received becomes $160. 👉 Explore more strategies for tracking crypto trades
The Evolution of Cryptocurrency Taxation in the U.S.
The U.S. has taken a proactive stance, defining cryptocurrency as property for tax purposes since 2014. This contrasts with countries like Germany and Portugal, which have offered more lenient tax treatments.
The IRS has actively enforced compliance. In a landmark case, it successfully compelled a major exchange to disclose data on thousands of high-volume users, leading to a wave of compliance letters sent to cryptocurrency holders in 2018.
Failure to meet tax obligations can result in severe penalties, including criminal prosecution, fines of up to $250,000, and imprisonment.
This latest guidance underscores the IRS's commitment to integrating cryptocurrency into the formal tax system and provides taxpayers with the much-needed clarity to remain compliant.
Frequently Asked Questions
Q1: Is transferring crypto from Coinbase to my private wallet a taxable event?
No. Moving your cryptocurrency between wallets or exchanges that you own is not a taxable event. You only create a tax liability when you sell, trade, or spend it.
Q2: How is staking reward income taxed?
Rewards from staking are considered taxable income at their fair market value on the day you receive them. When you later sell those staked coins, you will also owe capital gains tax on any increase in value since receipt.
Q3: What if I lost crypto in a hack or scam?
Theft or hacking losses can potentially be deducted as a capital loss. However, you must be able to provide evidence of the event and that the assets are truly unrecoverable. It is highly recommended to consult with a tax professional in these situations.
Q4: Do I need to report crypto trades if I didn't make a profit?
Yes. All taxable events, including trades that result in a loss, must be reported on your tax return. Reporting losses is important as they can be used to reduce your overall tax liability.
Q5: What is the difference between short-term and long-term capital gains for crypto?
If you hold a cryptocurrency for one year or less before selling or trading it, any profit is considered a short-term capital gain and is taxed at your ordinary income tax rate. If you hold it for more than one year, it is considered a long-term capital gain, which is typically taxed at a lower rate.
Q6: Where exactly do I report cryptocurrency on my tax return?
Income from crypto (e.g., from mining, staking, or as payment) is typically reported on Schedule 1 as "other income." Capital gains and losses from disposing of crypto are reported on Form 8949, with the totals then transferred to Schedule D.