Articles Posted in Cryptocurrency

Virtual currency, which the IRS defines as “a digital representation of value” that does not represent the U.S. dollar or any other national currency, has gained in popularity in recent years. For some, it offers an alternative to “real currencies” like the dollar for financial transactions. For others, virtual currencies offer investment opportunities. The IRS has held since 2014 that virtual currency is “property” for the purposes of federal income tax. A recent ruling, Rev. Rul. 2019-24, offers further guidance for investors and California tax advisors alike. The ruling addresses two specific events, known as “hard forks” and “airdrops.”

What Is Cryptocurrency?

Several key features define cryptocurrency and distinguish it from other virtual currencies:
Cryptography: Encryption protects cryptocurrency from forgery and other forms of manipulation. Many cryptocurrencies use blockchain technology, which creates a new and unique record every time a unit of currency is transferred.
Decentralization: Cryptocurrencies are not issued by any centralized financial authority. Instead, they are created through computing processes known as “mining.” Cryptocurrency transactions are logged on databases known as “distributed ledgers,” which are maintained across multiple computer systems, or “nodes.” This also protects against forgery or falsification of records.

Taxable Gross Income

Section 61 of the Internal Revenue Code (IRC) identifies various forms of “gross income” that is subject to federal income tax. This includes “gains derived from dealings in property.” The IRS ruled in 2014 that cryptocurrency is “property” for the purpose of calculating gross incomes.

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In recent years, taxpayers have been investing in virtual currency to exchange monies in the virtual marketplace or hold on to as investment assets. One of the subgroups of virtual currency is cryptocurrency, or a digital form of currency traded or secured using cryptography. The emergence of this digital asset has yet to provide definitive tax guidelines for taxpayers and tax practitioners, particularly for taxpayers who are concerned about their privacy rights in cryptocurrency. However, one thing is clear when it comes to virtual currency: taxpayers must pay their taxes on the gains made from the profits on virtual currency. If not, taxpayers will reap the consequences of enforcement from the IRS.

The IRS has provided some guidance to the virtual currency debacle in the form of Notice 2014-21. The IRS defines virtual currency as a digital representation of value that functions as a medium exchange, a unit of account, and/or a store of value. Virtual currency can act as a substitute for real currency, also known as “convertible” virtual currency, but does not have legal tender status in any jurisdiction. An example of a convertible virtual currency is Bitcoin, which can be digitally traded between users and exchanged into US dollars, Euros, and other real or virtual currencies.

Based on that comprehensive yet confusing definition of virtual currency, taxpayers may wonder how virtual currency might be treated for federal tax purposes. According to the IRS, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. That means taxpayers who receive virtual currency as payment for goods or services must include the fair market value of the virtual currency, measured in US dollars, the date that the virtual currency was received. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

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