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The IRS classifies investor assets into several categories. Explore the criteria for what a digital asset for tax purposes is.
August 13, 2024 · 4 min read
From real estate to cryptocurrency, the diverse assets in an investment portfolio collectively define their owner's total wealth.
Businesses and individuals hold assets for various reasons, including building a financial safety net or generating future income. Each asset class, whether tangible or virtual, carries distinct tax implications with specific rules, according to Internal Revenue Service regulations.
In this guide, we’ll explore the differences between virtual currency and other intangible properties and clarify what a digital asset is for tax purposes.
In general, digital assets are electronically-generated items that come in various forms, such as business logos, websites, e-books, and videos and have real-world value. If it's stored on a computer, transmitted electronically, and has economic value, it qualifies as a digital asset.
For tax purposes, however, the definition is more specific. According to the IRS, a digital asset represents real value recorded on a cryptographically secured, distributed ledger. This includes cryptocurrency, stablecoins, and non-fungible tokens (NFTs).
While the IRS recognizes virtual currency as one type of digital asset, not all digital assets fall under this category. For example, the IRS considers NFTs digital assets, but they don't typically serve as a means for purchases, which distinguishes them from virtual currencies. The IRS uses the term "virtual currency" for certain forms of cryptocurrency, whereas "digital assets" encompasses a broader range of properties.
Anyone filing forms 1040, 1040-SR, or 1040-NR must answer “yes” or “no” to whether they have received, sold, exchanged, or otherwise disposed of any digital assets during the year. The IRS uses this information to track and tax digital asset transactions.
Understanding how the IRS defines different types of digital assets is central to taxpayers accurately reporting their holdings and transactions. Here are the two main categories:
If a taxpayer holds a digital asset as a capital asset, they may have different tax implications from those who receive them as compensation. In these cases, the taxpayer must calculate their gain or loss on the transactions and report them on subsequent forms. Keeping detailed records of the price paid for a coin or token and the dollar amount received upon its sale is helpful when determining the fair value of a digital asset. The IRS likewise wants to know if the asset was first a gift before its eventual sale.
When a holder receives digital assets in exchange for goods or services, they’ll need to report their value (at the time of compensation). Employees who receive digital assets as income will find their value on their W-2 forms. If an independent contractor accepts the same assets, they may need to file separate forms to report their value accurately.
Reporting the fair value of a taxpayer's crypto transactions begins with answering the digital asset question on Form 1040. To comply with U.S. tax law, taxpayers must indicate "yes" or "no" regarding their virtual currency transactions on Form 1040.
Not every situation calls for a "yes" on your 1040 form when it comes to digital assets. Here are a few things to think about when deciding how to answer the IRS:
Understanding the world of digital assets is challenging enough; paying taxes on them shouldn't be.
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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.