Virtual Currencies aka Cryptocurrency such as Bitcoin and Ethereum continues to grow with more transactions occurring in today’s market and more crypto assets being mined for investment. Chris Cheng, Tax Supervisor at LMC and an IRS Enrolled Agent (EA), answers some frequently asked questions about cryptocurrency transactions and how taxes may be effected.
Q: I want to get into cryptocurrencies, what are the tax effects if the plan is to trade cryptocurrencies?
- A: If your plan is to buy, sell and trade crypto, you would view the transactions similar to how you hold stock in your brokerage account. You would have to keep track of your cost basis (price at which you purchased the currency) and the amount you sold it for to record your gain on the sale. The tax effect would be based on whether the crypto was held short term (less than a year) or long term (more than a year)
Q: What if I wanted to start “mining” for cryptos?
- A: If you wanted to “mine” cryptos you would have to record the fair market value of the “mined” crypto as “Other Income” on your tax return. The reported value of the other income will then become your Cost Basis and will be treated as a capital asset similar to stock transactions going forward.
Q: Am I allowed to deduct expenses for mining? Such as the “mining” equipment, maintenance, utilities etc…?
- A: If you treat the mining activity as a business, you are allowed to offset the income with any of the expenses incurred. If the business is profitable you may be subject to self employment taxes.
Q: Are there any consequences for not reporting my crypto assets?
- A: Yes. If you obtained cryptos thru mining or traded cryptos that was omitted from your tax return filing, you will have additional tax liabilities along with penalties and interest based on the additional tax due.
Q: There have been some companies offering high interest rates if we use them as a digital wallet. What would be the tax effect of the interest?
- A: The interest income would be reported on your tax return as interest income. If the interest is paid out in US Dollars then it is straight forward. If the interest is paid out in the virtual currency, you will have to keep record of the fair market value of each interest payment to be reported on your tax return.
Q: What is a NFT?
- A: NFT is short for Non-Fungible Tokens. A NFT is a unique digital code that is presented in the form of a text, image, video, and/or music clip.
Q: How is that different from crypto currency?
- A: An NFT is different from crypto currency in the sense that there is a visual or audio representation of what you are buying or creating. Unlike cryptocurrencies, where each coin/currency is the same, an NFT is unique and can be sold as a way to prove ownership over the digital code. These two digital items are both similar in the sense they are stored in digital wallets.
Q: What is the tax treatment for the sale and resale of an NFT?
- A: Creating or “minting” an NFT does not create a taxable event. A taxable event is created when the NFT is sold. The “minter” will record income from the sale as ordinary income subject to self employment tax. The IRS has not issued guidance on NFT taxation after the initial sale. Since NFTs share similarities with fine art or trading cards, some may consider NFTs to be considered as collectibles which would receive the higher 28% collectibles capital gains tax rate. Others can view the transaction as a capital event subject to short or long term capital gains tax rates. Contact your LMC professionals if you have more questions about an NFT.
As virtual currencies (cryptocurrencies) become more popular it is important that miners and investors keep accurate records of their cost basis in order to report any taxable events that may occur. Most recently in Biden’s Infrastructure Bill starting in 2023 companies that specialize in virtual currencies will be required to provide 1099 documents to their investors. Although companies will soon be required to provide information in the upcoming years, if you are planning to hold these assets in the longer term, the documents that companies will be providing you may have the wrong cost basis. For current cryptocurrency investors, it is important to use a reputable company that will be able to provide you with the necessary information to accurately file your tax returns.