Cryptocurrency Guide

Most any property with a lasting use or value, like a home, car, stocks and bonds or cryptocurrency, is a capital property. When an investment property (such as a cryptocurrency) is sold, a capital gain results if the sale proceeds are more than the cost of the property when acquired, plus any transaction costs. If the proceeds are less, it’s a capital loss. 

In the United States a capital gain or loss from a property held for:

• One year or less is a short-term capital gain or loss
• More than one year is a long-term capital gain or loss

Net long-term capital gain is: the long-term capital gains for the year less long-term capital losses including any unused long-term capital loss carried over from previous years.

Net capital gain is: the net long-term capital gain for the year less your net short-term capital loss for the year.

The tax rate applied to capital gains depends on one’s holding period (short or long term), taxable income, and filing status. Net short-term capital gains are taxed at the rate for ordinary income, and net long-term capital gains are taxed at specified rates. For 2023 tax rates, and also more info on capital gains, see A Guide to the Capital Gains Tax Rate: Short-term vs. Long-term Capital Gains Taxes.

The tax term for the cost of an investment property is cost basis. Like any investment property, the cost basis of cryptocurrency is the amount paid for it, including transaction fees, upon acquisition. Cryptocurrency can be received (and its cost basis established) in many ways. Some examples are when virtual currency is received: 

• As payment for having provided goods or services to someone
• As wages from employment services
• For no consideration (free)
• From NFT royalties
• From an airdrop
• From mining or staking
• From swapping for a previously held cryptocurrency 
• By purchasing it with fiat currency

A capital gain or loss will result from the disposal of cryptocurrency:

• As payment for goods or services received
• In exchange for cash
• In exchange for a different cryptocurrency

Capital losses are first used to offset capital gains of the same type. Short-term losses are first deducted against short-term gains, and long-term losses are deducted against long-term gains. Net losses of either type can then be deducted against the other kind of gain.

For example,

• If one has $2,000 of short-term loss and only $1,000 of short-term gain, the net $1,000 short-term loss can be deducted against net long-term gain (assuming you have one)
• If one has an overall net capital loss for the year, they can deduct up to $3,000 of that loss against other kinds of income, including salary and interest income
• Any excess net capital loss can be carried over to future years, to be deducted against capital gains and against up to $3,000 of other kinds of income
• If using married filing separate filing status, the annual net capital loss deduction limit is only $1,500

So, tracking and reporting these unused losses year to year for possible future use is important.

Having the correct cost basis is needed to determine the correct capital gain or loss amount, to report and pay the correct tax. So keeping records of all cryptocurrency deposits is really important.

Pitfall to avoid: a cryptocurrency can be moved from one virtual location (such as an exchange or wallet), to another location. The cost basis upon the initial acquisition is required for determining the correct capital gain or loss, if one needs to be reported at tax time. A subsequent wallet or exchange account (post-transfer) will likely not have a record of the initial cost upon the initial acquisition. 

Example:

• Jean bought one ExampleCoin on the Binance exchange in year 1, for $100 cash
• In year 2, Jean transferred the ExampleCoin to a Coinbase exchange, when the value of one ExampleCoin was $200. Transfer between accounts isn’t a taxable event
• In year 3, Jean sells the ExampleCoin for $300
• The year-end report that Jean receives from Coinbase lists a cost basis of $200 for the one unit of ExampleCoin that was sold (the value of the ExampleCoin when it arrived at Coinbase)
• Jean uses only a report from Coinbase and calculates an INCORRECT capital gain of:
  • $300 proceeds less $200 cost basis = capital gain of $100
• In fact, the CORRECT capital gain is:
  • $300 proceeds less $100 cost basis (original cost) = capital gain of $200

Jean may eventually receive an enquiry from the IRS, asking if the capital gain has been under-reported by $100. 

If one holds two tokens of a cryptocurrency that were acquired at different points in time, they will likely not have the same cost basis. If a token is sold, what cost basis amount is used to calculate the capital gain or loss? Is it the first token (known as first in, first out, FIFO), the last one (last in first out LIFO), an average of the two cost bases (average cost basis ACB), the highest cost token (highest in first out HIFO), or by picking one (specific identification)? 

The IRS allows specific identification. If specific identification isn't used, the IRS considers one to have used FIFO. Use of the same cost basis calculation method year-over-year is recommended so as to avoid double counting or missing any transactions.

As one's volume of disposal transactions increases, the required information gathering and calculations can become more daunting, exhausting and risky.

Using an automated cryptocurrency tax calculator is an option worth considering. One such option is described in the next section, What's Intelligent Tax Optimization?  

Review the following sections for more information about how each type of cryptocurrency is taxed.

Is cryptocurrency mining taxed?

Cryptocurrency compensation received from proof of work mining or proof of stake mining:

• From a business-like activity, is taxable as Business Income
• From nonbusiness activity, is taxable as Other Income

How's the reward from staking delegation taxed?

When a reward is received from staking delegation, the tax treatment depends on the type of reward. If the reward is for:

• Additional tokens, it's taxed as ordinary income
• An increase in the value of tokens already held, it's taxed as a capital gain

How's a hard fork taxed?

A hard fork, on its own, isn't a taxable event. If the hard fork is followed by receipt of new tokens, the tokens are taxable as ordinary income based on the fair market value at the time of receipt.

How's an airdrop taxed?

Tokens received from an airdrop are taxable as ordinary income based on the fair market value at the time of receipt.

How are decentralized finance (DeFi) arrangements taxed?

DeFi tries to mirror financial services like lending, borrowing, and earning interest, on a blockchain with no intermediary such as a bank. Existing ordinary income and capital gains rules can be applied to basic DeFi transactions. Tax treatment of more specialized DeFi arrangements can be reviewed at Decentralized Finance (DeFi) is red hot, but what are the tax issues?

How are decentralized autonomous organizations (DAO) transactions taxed?

A DAO may initially raise capital by receiving fiat currency (money) in exchange for its native token. It may invest in assets if there is consensus of approval.

When cryptocurrency is received from a DAO in exchange for goods or services, or via promotion upon a DAO launch, the cryptocurrency received will generally be taxed as income, similar to the general case when there's no DAO involved, say, as payment received for goods and services provided, or from air drops.

How are stablecoin and NFTs taxed?

In 2022, the IRS clarified its position: cryptocurrency, stablecoin, and NFTs, are all digital assets, subject to the same tax treatment. See Digital Assets for more information.

Yes, the following aren't taxable:

• Cash purchase of cryptocurrency
• Holding of cryptocurrency
• Transfer of cryptocurrency between wallets
• Receipt of cryptocurrency as a bonafide gift
• Gifting of cryptocurrency within these limits:
  • Any gift amount under the $17,000 (2023) annual gift tax exclusion limit 
  • Any gift amount over $17,000 but under the $12.92 million (2023) cumulative lifetime exclusion limit
  • For more information see Instructions for Form 709
• Donating cryptocurrency to a charitable organization
• Cryptocurrency transactions within a tax-deferred or tax-free account

1099 forms in general are intended for disclosing non-employment income. Currently with cryptocurrency there can be inconsistency in how and when the forms are used, and the completeness and accuracy of the information they contain. Note: Regardless of whether one receives a 1099 form, one is required to accurately report all cryptocurrency income to the IRS. 

Form 1099-B is issued by traditional investment brokers and exchanges to report a client’s individual securities disposals and gains or losses. Beginning in tax year 2023, US-based crypto exchanges must collect tax reporting information from their customers so that they can send them (and the IRS) 1099 forms. 

Form 1099-B contains potentially useful information for reporting cryptocurrency disposals, including the cost basis. One must use caution; see the prior section Why's cost basis so important, and what pitfalls must be avoided?

Form 1099-K shows the gross total of all transactions, both taxable, and nontaxable, on a given platform. For income tax purposes, each transaction needs to be reported. 

Form 1099-K tracks income you receive, usually through credit cards or processors like PayPal, Venmo, Square, Etsy, Uber, or Ebay, for selling goods or providing services.

You should receive a 1099-K if you made over $20,000 from more than 200 transactions.

Form 1099-K tells the IRS and the cryptocurrency investor that there's been potentially taxable cryptocurrency activity during the year. Taxable cryptocurrency transactions must be reported on the investor’s tax return regardless of whether a 1099-K has been issued.

Form 1099-MISC is issued to indicate total miscellaneous income. It's used by some cryptocurrency platforms to indicate other income of more than $600, from cryptocurrency staking, rewards and other sources of income. It doesn't disclose individual income transactions and it has no information about gains or losses. The individual income transactions must be imported or uploaded into the tax return software to be reported as either: other income if not self-employed, or as self-employment income if self-employed.

There's no available tax deduction for losses from lost or stolen cryptocurrency.