The Internal Revenue Service defines cryptocurrency as a “type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger such as blockchain.”
How is Cryptocurrency Taxed?
Although most countries treat virtual currency as standard fiat currency, the U.S. treats virtual currency as property for federal tax purposes. Under IRS Notice 2014-21, one must recognize a gain or a loss when exchanging virtual currency for cash or for other property. Therefore, every time virtual currency is sold or used to purchase goods or services, any gain or loss is taxable.
Gains and Losses
To determine the amount of capital gain or loss recognized, one must know the basics when purchased and fair market value when sold or transferred. The tax rate is then determined by how long the virtual currency is held before its sale or transfer.
- If sold or exchanged within one year, a short-term capital gain is realized.
- If sold or exchanged after one year, a long-term capital gain is realized.
Currently, long-term capital gains are taxed at a lower rate than short-term capital gains.
Fair Market Value
Determining the fair market value of a virtual currency depends on how the virtual currency is acquired.
- If acquired through a crypto trading platform or exchange, the value is the amount that is recorded by the crypto exchange for that transaction.
- If acquired “off-chain,” (not recorded on the distributed ledger), the fair market value is the amount it was trading for on the exchange at the date and time the transaction would have been recorded on the ledger.
- If acquired in a peer-to-peer transaction or some other transaction that does not involve an exchange, the fair market value is determined as of the date and time the transaction is recorded on the distributed ledger or would have been recorded on the ledger if it is an “off-chain” transaction.
The basis is the amount paid for the crypto plus any transaction fees. Since crypto is considered property, every single transaction must be tracked by the basis for which it was acquired and by the amount earned from the sale.
- For example, Mary paid $15,000 to purchase one bitcoin. It cost $14,998 for the bitcoin and $2 for the transaction fee. Her basis in the one bitcoin would be $15,000.