This is a newer tax situation, so there's not much specific instruction from the IRS, but they have made it clear that cryptocurrency is taxable as capital asset sales, just like stocks. I'm going to answer your questions in a different order.
- 3) Just like stocks, regardless of if you received cash, any trade, exchange, etc. is considered a sale. This would include reinvesting earnings, just like reinvesting stock dividends or earnings from a stock, into another stock. Obviously with Cryptocurrency and the situation you are describing this can be a tedious calculation. I've heard some people are tracking this with complex spreadsheets.
It sounds like you are aware that also using cryptocurrency to make a purchase of goods or services, results in a capital sale (but worth mentioning!), so the treatment is consistent.
- 1 &2 ) Yes, that's correct, but not the full $5,000. If you report $800 of hobby income, you can only report $800 of hobby expenses. Hobby expenses are only deductible up to the amount of earnings, as an itemized deduction (not directly from the income). The hobby expenses are then reduced by 2% of your Adjusted Gross Income (a subtotal on page 1 of your 1040, which includes your hobby income). So, you can loose the entire deduction fairly easily at this point, depending on your AGI. Additionally, as a deduction, this may not benefit you at all unless you itemize (if you take the standard deduction there's no deduction).
While hobby may be a smart distinction because this could save you time in entry, if you choose to do a hobby, I wouldn't recommend changing it when it's more favorable to you. The hobby classification is a strict classification and if your goal is to make a profit, then you don't qualify. Hobby income is reported on line 21, as other income. Learn more about classifying your activity as a hobby here: https://www.irs.gov/newsroom/is-your-hobby-a-for-profit-endeavor
Additionally, your $5,000 investment is your cost basis in the cryptocurrency. When you sell, trade, etc. your cost basis reduces the sale price, to equal your gain or loss. This would be most likely be more advantageous anyway. Also, investment expenses can be deducted as an itemized deduction too, but this doesn't include your cost basis of purchasing.
Some good resources:
