Cryptocurrency investments and trading are taking the country by storm. According to CNBC, 21% of Americans have traded cryptocurrency as of March 2022. As cryptocurrency trading gains popularity, many taxpayers have questions about how cryptocurrency trading is taxed.
The principal activity most individuals engage in is trading cryptocurrency. The IRS treats trading cryptocurrency the same as trading property. For the most part, these trades follow the same rules as stocks (securities). The short-term and long-term holding rules apply along with applicable capital gains tax rates. Just like with stocks, only sales and dispositions of cryptocurrency are reported for income tax purposes.
There are also some differences when trading cryptocurrency compared to securities. First, the federal wash sale rule does not apply to property, so all sales are fully recognized on form 8949 and Schedule D for capital gain/loss activity. Second, basis reporting can be more challenging than with trading securities. The cost basis for sold securities is generally tracked and accounted for by brokerage firms on your behalf. However, many cryptocurrency wallets, sites, and applications do not track basis in a clear, reportable format. Therefore, it is important that you track your cost basis closely when you execute sales. You should consult a tax professional about the multiple methods available to report basis (such as FIFO and specific identification if you have questions). Additionally, services that access a wallet and provide a draft form 8949, showing proceeds and basis for cryptocurrency dispositions for a given year, are handy when preparing your taxes.
Cryptocurrency can also be acquired outside of trading. The rules surrounding these acquisitions are significantly different than when trading. Receiving cryptocurrency as a gift is not taxable for the receiver but may need to be reported for gift tax purposes by the sender (which is true for any gifts sent).
Cryptocurrencies are also being used as payments to individuals for services rendered. If the payment is between an employee and an employer, the fair market value (FMV) is reported as wages on Form W-2, and the wages are taxed as ordinary income and subject to payroll taxes. If the payment is made to an independent contractor, the FMV is the contractor’s revenue for that transaction and will be considered revenue subject to self-employment tax. This is true whether the work completed was directly related to cryptocurrencies (e.g., mining) or for an unrelated task.
Another form of receiving cryptocurrency is when an individual receives cryptocurrency as a marketing method, often for doing nothing in return. This transfer is known as an airdrop. In this case, the FMV of the token when it is received is recognized as ordinary income but would not be subject to self-employment tax, provided that no services were rendered in exchange for the received tokens. For any token received, whether as a gift, compensation, or airdrop, an individual’s cost basis upon a disposition is the FMV upon receipt.
Cryptocurrency is an emerging, novel part of the current economy. It should be noted that Congress is considering legislation that could change or clarify some rules surrounding cryptocurrency transactions. Therefore, staying up to date with potential changes is advised.