Though cryptocurrency bursts onto the scene as a trendy, more clever way to invest, receive payments, and make purchases compared to the transparency of traditional currency, it’s still viewed by the IRS as a source of income. Therefore, it’s still subject to taxes under certain circumstances.
When Do You Owe Taxes on Cryptocurrency?
Anytime you generate an income from cryptocurrency, you are required to report the income on the tax return you filed at the start of the year. This information is typically sent to you via 1099 forms, which you must then use to fill out form 8949 and, ultimately, your 1040 tax form.
Some examples of taking in income from cryptocurrency include:
You Earn, Buy, or Spend Cryptocurrency
Anytime you purchase or receive cryptocurrency and then turn around and spend or sell it, it is considered a capital transaction, in which case, it is viewed the same as if you were to sell shares of stocks, meaning it results in a loss or gain based on the fair market value.
This means if you earned crypto as income either in exchange for your services, as interest, as a referral reward, etc., then you would report ordinary taxes on the fair market value of the crypto when you received it.
In the meantime, let’s say the fair market value of the crypto increased since you earned it, and then you turn around and spend it, then you would also pay a capital gains tax on the amount it increased in value since you first received it.
Likewise, say you buy a cryptocurrency and then maybe months or years later you trade the cryptocurrency for goods and services, then you would also incur a capital gains tax.
If you sell crypto for fiat currency, it is also considered a taxable event, in which case you will also incur a capital gain or loss.
- You Mine Cryptocurrency
If you earn cryptocurrency in exchange for mining it, then it, too, is considered taxable income, in which case, you will need to report it, just like self-employment income, at its fair market value when you receive it.
- You Trade One Cryptocurrency for Another
Trading one crypto for another is also considered a taxable event. Hence, you will owe tax on the gain you made from the appreciation of the original cryptocurrency when you exchanged it for another of the same value.
How Does the IRS Enforce Cryptocurrency Tax Reporting?
Broker-dealers and some cryptocurrency exchanges generate an IRS Form 1099-K that is then sent to both you and the IRS, which shows your total proceeds of cryptocurrency transactions each month. Hence, the IRS understands who are high transaction users.
In the meantime, the IRS has also begun inquiring on the 1040 Form if at all during the year you sold, sent, received, or exchanged virtual currency.
If you check yes, you will most likely need to include the income from your cryptocurrency transactions on your tax return.
In the end, once you sell your cryptocurrency for fiat currency, you can also open a bank account with SoFi, which according to the experts at SoFi, “…and earn 1.00% APY on checking and savings.” Plus, it will also help make keeping your tax records easier.