IRS Clarifies Crypto Tax Question on 1040 Tax Returns

The IRS instructs how to answer the crypto tax question on tax returns.

Shehan Chandrasekera, CPA
Shehan Chandrasekera, CPA

October 25, 2020  ·  3 min read

IRS Clarifies Crypto Tax Question on 1040 Tax Returns

The IRS released another version of draft instructions on December 31, 2020. This new version further clarifies what's covered by the term "virtual currency" and requires you to check "yes" on the infamous crypto tax question on page 1 if you purchased crypto during 2020. This language was not included in the previous draft instructions dated October 23, 2020.

2020 draft instructions released as of December 31, 2020

2020 Draft instructions released as of October 23, 2020

On Oct 23, 2020, the IRS released instructions to the draft 2020 Form 1040 which contains the infamous virtual currency question: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?

During the 2019 tax filing season, many taxpayers and tax practitioners were confused if they had to check “yes” if someone only held crypto in a wallet without making any transactions and/or moved funds between wallets owned by the taxpayer.

When you can answer “no” to the virtual currency question

Under the newly released instructions, taxpayers can check “no” for the crypto question, if they only held cryptocurrency in wallets or transferred them between their own wallets during 2020.

A transaction involving virtual currency does not include the holding of virtual currency in a wallet or account, or the transfer of virtual currency from one wallet or account you own or control to another that you own or control.

Hodlers who care about privacy will welcome this added language because they won’t be required to disclose their positions to the IRS.

Hodling and moving crypto between wallets you own are not subject to capital gains taxes.

When you must answer “yes” to the virtual currency question

You will still have to check "yes" if you have come across following situations in the tax year:

  • Received crypto (include from an airdrop or hard fork)
  • Sold crypto for fiat (ex:- cashing out bitcoin on Coinbase)
  • Traded crypto for another crypto (ex:- spending bitcoin to buy Ethereum)
  • Used crypto to buy goods or services (ex:- using a crypto debit/credit card to buy a cup of coffee)

Selling crypto into fiat, trading crypto for another crypto and using crypto to buy goods and services are taxable events and subject to income tax. You are responsible of calculating the cost basis and resulting tax liabilities.

Bitcoin taxes are still ambiguous

Even with the new draft instructions provided by the IRS, the guidance is still far from being comprehensive. For example, we still don't know whether a taxpayer who owns bitcoin through a pass-through entity needs to check “yes” for the question. The “financial interest” portion of the question is still subject to interpretation.

The instructions are still in draft form. However, the added clarity to instructions suggests that this question will most likely end up on the final Form 1040.

If you have any questions or comments about crypto tax and IRS forms, let us know on Twitter @CoinTracker.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.