What is the relationship between cryptocurrencies like Bitcoin and the IRS? I remember starting out as a freelance writer and not understanding how certain tax requirements applied to me–I missed out on thousands of dollars in business-related tax write-offs because I was ignorant of the rules.
The same kinds of problems are possible with cryptocurrency–if you don’t know how the IRS classifies assets like Bitcoin, Ethereum, or others, you could wind up with a tax liability or a set of assumptions about your investment that aren’t in line with reality. It’s best to know the rules before you need them.
What should you know about Bitcoin and the IRS? What follows is NOT to be construed as tax advice–this is information I have learned through my own personal research and I am passing along what I have found works for me personally–your mileage may vary.
How The IRS Classifies Cryptocurrency
The IRS official site has a definition of cryptocurrency (they call it “virtual currency”) describing it as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value” but stresses that such currency does not have standing as legal tender “in any jurisdiction”.
That’s the classification of virtual currency or cryptocurrency. But how does the IRS classify it for tax purposes? In the eyes of the Internal Revenue Service, Bitcoin and other such currencies are property, not currency. That means it may be subject to the kinds of taxation other property is assigned. If you realize some form of financial gain from a Bitcoin transaction, you may be liable for federal taxes.
How Will The IRS Find Out?
Some will trade in cryptocurrency, make some earnings, but fail to report them on their taxes. It is easy to ask “How will the IRS ever know I traded online in the first place?”
A Bloomberg report published in 2019 warns that the Internal Revenue Service has put cryptocurrency on its list of enforcement priorities, thanks in part to the agency’s victory in a lawsuit that required a digital currency exchange called Coinbase to surrender customer data to the IRS.
That data included contact information on all who bought or sold $20 thousand in cryptocurrency or more between 2013 and 2015. The IRS is going after cryptocurrency tax scofflaws.
No Tax Break For Loss Or Theft Of Crypto Assets
The IRS has in the past issued rules that deny taxpayers any federal tax break over lost or stolen cryptocurrency assets. You may have no deduction for such losses at the federal level. However, tax laws change frequently and what is permitted today is denied tomorrow, and vice versa. Always consult a tax professional about current IRS guidelines for crypto and related issues.
It should be noted that the rules we are discussing here do NOT apply to capital losses or the IRS rules that govern such losses. Capital gains and losses are governed differently and you may, depending on current IRS guidelines (again, consult a tax pro) be able to deduct capital losses related to cryptocurrency. Remember, you cannot claim losses with Bitcoin or any other virtual currency without also reporting any gains when they occur. Discuss these issues with a tax preparer or other qualified professional for best results.