Last Updated: September 29, 2020
The IRS has not provided any guidance on crypto taxation since the Notice 2014-21 issued in 2014. After nearly five years, on October 9, 2019, the IRS elaborated on the original guidance in an FAQ and an associated Revenue Ruling 2019-24. These shed more light into controversial topics such as how to calculate cost basis, airdrops, forks, and gifts. We’ll highlight the key points you need to know.
For the first time, the IRS provides a definition for cryptocurrency. Source: A3
'Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A transaction involving cryptocurrency that is recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction.'
IRS Notice 2014-21 only defined and explained virtual currencies and convertible virtual currencies.
In the new guidance, one of the more controversial changes is that hard forks resulting in a new coin being “airdropped” to your wallet is taxed as income (note: the terminology of using airdrop at the time of a fork is not correctly used by the IRS and causes some confusion; the contextual clues indicate that they mean when multiple coins emerge in your control from a hard fork). This ordinary income realized is equal to the fair market value of the new cryptocurrency when it is received. If you do not receive new cryptocurrencies after a hard fork, you will not have any taxable income. Source: A21, A22, A23, A24
This is particularly controversial because there are myriad scenarios in which users can face taxable income without knowing or without wanting to receive it. For example, millions of Americans received BSV as a result of a bitcoin cash (BCH) hard fork. Due to limited liquidity and delisting of the asset on many exchanges, these taxpayers are now faced with income on this asset that is difficult for them to dispose of.
Soft forks occur when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency. Soft folks are not taxable because you are not receiving new cryptocurrency. Source: A29
How to Identify Basis
In terms of cost basis calculations, the IRS specifies guidance on exactly how to value crypto-assets. If you trade crypto on an exchange, the dollar value for crypto traded should be determined by the USD price at that specific exchange. This means using sources like CoinMarketCap would not be acceptable anymore.
If you traded crypto peer-to-peer, via a decentralized exchange, or via some other method that did not involve an exchange, the fair market value of the crypto traded should be determined by referring to “a blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculated the value of cryptocurrency. If you do not use an explorer value, you must establish that the value you used is an accurate representation of the cryptocurrency's fair market value.” CoinTracker for example takes care of this for you by using sophisticated data aggregators like Nomics which will sufficiently fulfill this requirement.
Finally, if you receive cryptocurrency for which you cannot find a published value (very common in the crypto world), the fair market value of the crypto received is equal to the fair market value of property or services exchanged. Source: A2, A25, A27
Another major update is that specific identification is now officially an accepted accounting method for trading crypto assets (otherwise the default fallback is first-in-first-out or FIFO). This means taxpayers can pick and choose which unit to be disposed as long as they can support the cost basis of those units. Source: A36
To successfully identify a specific unit, information must include:
- the date and time each unit was acquired,
- your basis and the fair market value of each unit at the time it was acquired,
- the date and time each unit was sold, exchanged, or otherwise disposed of, and
- the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit
If the taxpayer can not specifically identify the units as described above crypto assets sold or exchanged are deemed to be disposed under first in first out (FIFO) basis. Source: A38
Taxpayers are also required to maintain records that are sufficient to establish the positions taken on tax returns. You should therefore have records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.
This is where basis tracking becomes extremely important. Luckily, CoinTracker can help you with tracking basis and record keeping in accordance with the new IRS guidance and help you dispose the units with the least amount of tax impact, including by tracking assets by wallet or universally, and by using techniques such as highest in-first out (HIFO) accounting. Source: A39, A43
Gifts and Donations
If you receive crypto as a gift, you will not have to recognize any income. Determining the basis of the gift received is somewhat complex. The basis of the gift received is dependent upon the gain or loss at the time you dispose of it. Source: A30, A31, A32
Additional good news: when you donate crypto assets to a charity, it will not trigger a gain or loss. If you have held the asset for more than one year, you are eligible for a deduction equal to the fair market value at the date of donation. If you have held the asset for one year or less, you are eligible for a deduction equal to the lesser of the fair market value or the cost basis at the date of donation. This means that you may donate appreciated crypto assets to charities and bypass capital gains taxes! Source: A33, A34
The IRS has confirmed that if you pay somebody in crypto and/or use cryptocurrency to purchase goods and services, that will trigger a capital gain or loss. The gain and loss is equivalent to the difference between cost basis and fair market value at the date of disposition. Source: A13, A15
Transferring crypto from your wallet to other wallets (or exchanges) which belongs to you is a nontaxable transfer. These transactions may be included in Form 1099-K by crypto exchanges but even if you receive a 1099-K, those transactions will not be taxable. This is a great relief for taxpayers who received various tax notices (CP2000, 6173, 6174-A & 6174) related to 1099-Ks. Source: A35
Note: these rules only apply to taxpayers who hold virtual currency as a capital asset. Per IRS publication 544, capital assets include everything you own (including crypto) and use for personal purposes, pleasure, or investment purposes
It is great to see the IRS bringing more clarity to cryptocurrency related transactions. The majority of the items mentioned in the new FAQs are taxpayer friendly. Solid substantiation of your crypto transactions and proper reporting based on new guidance will be extremely important for taxpayers in the future. CoinTracker can help you comply with new IRS guidance and make you not worry about crypto taxes.
Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.