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How to Know When Your Cryptocurrency Is Taxed

Bitcoin and other cryptocurrencies have transitioned from an underground fiat economy to mainstream acceptance. With the crypto market value topping out at $2.6 trillion in 2021, its clear that a decentralized economy is hatching right before our eyes.

No longer is paying through the blockchain a dark art. Now you can pay your AT&T phone bill in Bitcoin. Now you can add cryptocurrency to your IRA. Now you can pay for your Home Depot purchase with crypto. And now the IRS wants their fair share of your digital assets, and they intend to get it.

Whether you have a few bitcoins rattling around in your digital wallet, or if you are exploring how to add cryptocurrency to your investment portfolio, beware. The IRS is getting serious about crypto tax enforcement and not knowing when to report gains and losses can cost you big in IRS penalties.

But relax. Not everything you do with cryptocurrencies is taxable. Let’s look at what events trigger a reporting requirement and require you to pay the IRS.

Taxable and Non-Taxable Events Involving Cryptocurrency
The IRS released its first regulations for taxation of crypto, called Notice 2014-21 in 2014. In its notice, the IRS declared that virtual currency is treated as property for tax purposes, rather than as currency. The IRS supplemented the notice with a FAQ page titled Frequently Asked Questions on Virtual Currency Transactions. To date, those represent the basics of how the feds will look at your crypto transactions. Let’s see if we can make those a little simpler for you.
Simply buying and holding bitcoins, Ethereum, or other virtual currencies is not a taxable event—if you bought your crypto with U.S. dollars and kept it in the exchange where you bought it.

What triggers a taxable event with your crypto is when you do something with it other than buying and holding it. While crypto tax regulations are complex and evolving, the following questions can help you determine if your actions will make your crypto taxable:

• Have you sold any crypto for fiat currency, such as the US dollar or Euro?
• Have you received any crypto for payment for goods or services that you provided?
• Have you received any crypto currency for free?
• Have you exchanged one cryptocurrency for another?
• Have you disposed of your financial interest in cryptocurrency?
• Have you received any crypto from an airdrop, hard fork, or mining operation?
• Have you exchanged crypto for property, goods or services?

Since virtual currency is property, your crypto is not counted as income on your 1040. However, as property, if you do more than buy and hold it, you will be subject to reporting capital gains and losses.

Reporting Crypto to the IRS
If—again, a very important distinction—you only bought and held crypto, you do not need to report your purchase in calculations on your 1040 tax return. You do need to answer a new question the IRS placed on the 1040 beginning with 2021, which asks if you received, sold, sent, exchanged, or otherwise disposed of any financial interest in any virtual currency. Even though your simple purchase of virtual currency does not make you owe taxes on it, the IRS still wants a statement from you letting them know your involvement with crypto, if any.

And How About NTFs?
Non-fungible tokens, or NFTs as they are commonly called, pose yet another opportunity for you to run afoul of tax regulations. NFTs are digital assets that prove ownership of unique digital or physical items. These items could be anything from digital art, real artwork, real estate, videos, music, computer code, or most anything else that is one-of-a-kind and that you might buy, sell, collect, trade, or invest in.

Yes, NTFs have become a thing. The uses for them runs the full gambit, from ensuring ownership of million-dollar collectable art to selling computer-generated images of a rock.

Like crypto itself, simply buying and holding NFTs is not a taxable event, even if the value of your NFT changes. If you sell, trade, or otherwise dispose of your NFTs, then you have to report it, whether you had gains or loses.

But wait, the IRS has more. Since NFTs can include smart contracts, you might sell an NFT but receive a profit from the buyer if they earn money on the item the NFT represents. A simple example might be that you sell an NFT representing a song. You might have your contract with the buyer written such that you receive a royalty each time the song is performed live. In that case, you would owe taxes on the profit you make, even after selling your NFT. Banging your head against the wall yet?

Avoiding IRS Penalties
Both taxes and virtual currencies are complex in their own right. Intertwine the two and you have a virtual minefield when it comes to avoiding making costly mistakes with the IRS. To make matters worse, most crypto experts do not understand IRS regulations and most tax experts do not understand crypto. Where can you turn to make sure you experience the fun and profit that crypto can offer while keeping the feds from coming after you?

Fortunately, help is only a phone call away. Tom Jones, founder of Tom Jones Taxes, is a registered agent with the IRS, a seasoned tax professional, and he knows crypto. Whether you are just delving into virtual currencies or running a red-hot Bitcoin mining operation, Tom Jones can help you achieve compliance with both state and federal taxation requirements. Why not call Tom now for a one-on-one consultation?