Updated Form 1040 Crypto Asset Question

“At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” This new question appears on IRS Form 1040, and taxpayers are required to answer. More than half of new Bitcoin investors joined the platform within the last 12 months, so there are taxpayers who are completely new to the market, and its potential tax implications. Given the new disclosure requirement, it is essential for Atlanta investors to understand the federal tax treatment of cryptocurrency investments. To help clients, prospects, and others, Wilson Lewis has provided a summary of the key details below.

How is Cryptocurrency Taxed?

For the most part, cryptocurrency is taxed as property in the U.S., not currency. It’s a digital representation of value that “functions as a unit of account, a store of value, and a medium of exchange.”

That means it’s subject to different tax rules than wages, salaries, tips, and so forth. Being taxed as property exposes cryptocurrency to capital gains tax rates. Short-term capital gains or losses apply to cryptocurrency held for one year or less, while long-term capital gains or losses apply to investments held for more than a year.  Short-term capital gains are taxed at the ordinary income tax rate while long-term capital gains are subject to a tax rate of up to 20 percent, depending on income.

The holding period begins the day after the cryptocurrency was acquired and ends on the day it is sold or exchanged. The amount of gain or loss, also known as the cost basis, is the difference between how much the taxpayer paid for the cryptocurrency when it was acquired versus how much they received when the cryptocurrency was sold or exchanged. The cost basis may need to be adjusted based on fees incurred to acquire the cryptocurrency.

Tax treatment of non-fungible tokens (NFTs) is more of a gray area in U.S. taxation. Most NFTs are treated as collectibles for tax purposes, which still subjects them to capital gains taxes, like property. Specific tax implications of NFTs depend on whether the taxpayer is a creator or investor and to what extent the taxpayer interacts with NFTs, as a hobby or a business. A hobbyist who makes NFTs for fun could not deduct any business expenses yet would still be responsible for capital gains or losses. Selling the NFT is a taxable event, and so is receiving royalties.

New 1040 Disclosure Requirements

The question about cryptocurrency first appeared on Form 1040 for the  2020 tax year. In this year’s version, the wording is slightly revised and is meant to be clearer.

Merely holding cryptocurrency does not create a tax exposure. Taxpayers can confidently check No on their 1040 if activities in 2021 were limited to any of the following scenarios.

• The cryptocurrency was owned or held but was not transferred to another taxpayer.
• They only transferred cryptocurrency between their own virtual wallet or accounts.
• The cryptocurrency was purchased using real currency, including on platforms like PayPal or Venmo.
• Any combination of the above.

However, most other scenarios will require filers to check Yes on 1040. For example, if any of the following transactions occurred, there may be a tax liability.

• Received or exchanged virtual currency for payment of goods or services, or for another virtual currency.
• Received or transferred cryptocurrency, except if it was a bona fide gift.
• Crypto mining and staking activities resulted in a new virtual currency.
• A hard fork occurred and resulted in the receipt of the new cryptocurrency.
• The taxpayer sold any unit of virtual currency.
• Any other disposition of virtual currency not listed above.

Bonafide cryptocurrency gifts to charitable organizations are generally equal to the fair market value at the time the donation was made.  Cryptocurrency charitable gifts where the virtual currency was held for less than a year are calculated differently. The deduction in those cases is the lesser of the taxpayer’s basis or the fair market value at the time of the donation. Organizations can provide taxpayers with a written acknowledgment for gifts valued at $250 or more. Those who claim a virtual currency donation of $5,000 or more must obtain a signed Form 8283 from the organization. 

Gifts to an individual do not count and the IRS may not accept gifts without documentation.

How to Decrease Cryptocurrency Tax Liability

Taxpayers who sell, transfer, or otherwise dispose of cryptocurrency have options to minimize tax liability.

The first consideration is to wait at least one year before disposing of crypto assets, so any gain is recognized as a long-term gain and not subject to the ordinary income tax rate.

Along those lines, it’s helpful for taxpayers to think of crypto assets as an investment portfolio. Tax-loss harvesting, where losses in one area can offset gains in another, can be a useful strategy. There is also the option to open a crypto IRA or make charitable donations using cryptocurrency.

If a Taxpayer Checks Yes to Cryptocurrency on 1040

If circumstances indicate that a taxpayer has incurred tax liability from the sale, exchange, or receipt of cryptocurrency, they must use Form 8949 to report capital gains or losses. The amount should also be reported on Schedule D of 1040. 

It’s important for those involved in cryptocurrency to keep accurate records of cost basis, dates acquired, sold, or transferred. Crypto exchanges aren’t currently required to send Form 1099s to most individual investors, though that could be changing in the future. Even then, the values may be incorrect because exchanges currently have no way of verifying how much was paid for a crypto asset, only how much it sold for.

Contact Us

The continued interest by the IRS in taxing cryptocurrency and other digital assets means careful attention should be paid to potential tax issues. If you have questions about the information outlined above or need assistance with a tax or accounting issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.