Potential Tax Hurdles with Virtual Currency — What to Tell Clients

by Karolis Matulis, CPA, WilkinGuttenplan | January 22, 2020

With the 2019 tax filing season quickly approaching, we should be looking at and planning for new tax developments. For example, a new question can be found on the 2019 Schedule 1 (Form 1040): “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

On the surface, the question seeks to identify taxpayers who are potentially noncompliant; more importantly, it serves as a reminder for tax practitioners to bring up the topic with their clients.

While virtual currency (cryptocurrency) reporting is relatively simple, there are several potential hurdles to be aware of. Many taxpayers are simply unaware that virtual currency may have income tax implications, especially when exchanging between two different kinds of virtual currency. Unlike brokerages, cryptocurrency exchanges are currently not required to issue any tax reporting summaries to taxpayers. As such, taxpayers may not relay any information regarding their activity to tax practitioners. The burden of tracking activity and appropriate reporting falls on the taxpayers and their tax preparers.

Tax preparers and taxpayers should, however, consult IRS Notice 2014-21 and the recently issued Revenue Ruling 2019-24 for an in-depth analysis of the taxability of virtual currency but some key concepts include the following:

  • For federal tax purposes, virtual currency is treated as property. As such, basic principles that apply to property transactions apply to virtual currency transactions. Virtual currency is not treated as currency and does not generate any foreign currency gains or losses.
  • The cost basis of virtual currency is the fair market value as of the receipt date (via exchange or as payment [for goods or services]). Fair market value should be denominated in U.S. dollars. As such, the fair market value (in USD) of the currency should be determined with the use of exchange rate information from cryptocurrency exchanges.
  • A taxable income event occurs anytime the virtual currency is disposed of by means of exchange or use (for goods or services). Proceeds are determined by the fair market value as of the disposition date.
  • It is important to note that exchanges between different types of cryptocurrencies are taxable events. Many taxpayers are aware that exchanging dollars for Bitcoin back to dollars constitutes a taxable event; what is less known is the fact that each currency is considered a different kind of property. Thus, the exchange between two different currencies such as Bitcoin and Ethereum is also a taxable event.

Tracking/computing basis for taxpayers with few annual transactions and few currency pairings can often be managed manually. Many exchanges allow taxpayers to export their annual trading activity to friendlier formats such as Excel. But, for taxpayers with significant trading activity, manual tracking can be virtually impossible. Luckily, there are several cloud-based software packages that can simplify the process. Many of these packages allow for data imports via exchange API, currency wallet address, and Excel. These packages are typically able to generate all the relevant Form 8949 input and track basis going forward.

For more information on virtual currencies, check out the NJCPA's Emerging Technologies Interest Group (#NJCPATech).

Karolis  Matulis

Karolis Matulis

Karolis Matulis, CPA, CVA, is a supervisor at WilkinGuttenplan. He is a member of the NJCPA Emerging Technologies Interest Group (#NJCPATech).

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