When you have digital asset transactions, you must report the results in taxable gain or loss. You should:
- Keep records
When you had digital asset transactions, keep records that document:
- Your purchase, receipt, sale, exchange or any other disposition of the digital assets,
- The fair market value as measured in U.S. dollars of all digital assets received as income or as a payment in the ordinary course of a trade or business
The Internal Revenue Code and regulations require taxpayers to maintain sufficient records to establish the positions taken on federal income tax returns. The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns.
Obtain and maintain with your tax returns package (i) records documenting receipts, (ii)sales, (iii) exchanges, or (iv)other dispositions of virtual currency and (v) the fair market value of the virtual currency.
Collect all documents from the brokerage houses such as Coinbase, Gemini, etc. For all missing items, prepare and maintain documents based on your good-faith estimates. In the case of an IRS audit, pre-existing documents carry more evidentiary value.
- Calculate your capital gain or loss
To calculate the capital gain or loss of a digital asset that you sold or disposed of in a transaction, you’ll need this information:
a. Type of digital asset
b. Date and time of transaction
c. Number of units
d. Fair market value at time of transaction (as measured in U.S. dollars)
e. Basis of digital asset sold or disposed of
Determine how to calculate gain or loss. Identify the units sold or disposed of and determine fair market value for your transaction.
Tax Tip # 1. If you own and use a digital asset for personal or investment purposes, the income would be taxed as a capital gain or loss when you sell or dispose of it.
Tax Tip # 2. If you held the digital asset as a capital asset for one year or less before selling, exchanging, or otherwise disposing of the digital asset, you will have Short-term capital gain, which is taxed at a preferential tax rate.
Tax Tip # 3. If you held the digital asset as a capital asset for more than one year before selling, exchanging, or otherwise disposing of it, you will have Long-term capital gain.
Tax Tip # 4. If you receive a digital asset in exchange for goods or services in a business context, the income would be taxed as ordinary income or a loss.
- Calculate your digital asset basis
The basis of property is its cost. Generally, the basis of a digital asset is the cost in U.S. dollars. Determination of your basis for digital assets depends on the type of transaction you owned before its sale or disposition. To determine your basis, you’ll need the following:
a. Type of digital asset such as Bitcoin
b. Date and time you purchased the digital asset
c. Number of units of the digital asset you purchased
d. Fair market value of your digital asset when purchased measured in U.S. dollars
4. Report digital asset transaction on the IRS correct form
The pertinent IRS form you use depends on the type of transaction:
- If you sold, exchanged or otherwise disposed of a digital asset you held it as a capital asset. Use IRS Form 8949. This Form is supplementary for the IRS Schedule D, and results of all Form 8949 flow through to Schedule D.
(b) If you have other ordinary income related to digital assets. To report income from forks, staking, mining, etc., use IRS Form 1040 (Schedule 1).
(c) If you gave a gift in the form of digital assets. Use IRS Form 709 Tax Return.
(d) If you received compensation as an employee with digital assets. For compensation you receive as an employee, report the digital asset income on IRS Form 1040 Tax Return.
(e) If you received compensation as an independent contractor with digital assets. Report the digital asset income on Schedule C (Form 1040) Profit or Loss from Business (Sole Proprietorship).
(f) If you sold, exchanged or otherwise disposed of digital assets to customers. Report these transactions on Schedule C (Form 1040) Profit or Loss from Business (Sole Proprietorship).
(g) If your S Corporation received income with digital assets. Report these transactions on IRS Form 1120S. U.S. Income Tax Return for an S Corporation.
(h) If your Partnership received income with digital assets. Report these transactions on IRS Form 1065 U.S. Return of Partnership Income
Source: Internal Revenue Code with modifications and emphasis by Zaher Fallahi, Crypto and NFT Tax Attorney, CPA.
Zaher Fallahi, Tax Defense Attorney, CPA, assists taxpayers nationwide with Cryptocurrency and Non-Fungible Tokens (NFT) Tax, Foreign Gifts & Inheritance, Delinquent FBAR filing, IRS audits, Offer-In-Compromise, Undisclosed Foreign Bank Accounts, and International Tax Matters. Tel.: (310) 719-1040, (714) 546-4272 and (877) 687-7558 toll free nationwide. Websites: zflegal.com and zfcpa.com E-mail taxattorney@zfcpa.com