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Virtual Currencies and Income Taxes

Virtual
Currencies

Just as any other currency, a virtual currency or crypto currency might be used to pay for goods or services or used as a form of an investment.

You can report virtual currency transactions for your 2020 tax return on eFile.com; start preparing and e-Filing now!

Generally, virtual currencies are a digital representation of value that functions as a medium of exchange. Virtual currencies have an equivalent value of another real currency, such as the U.S. Dollar, Euro, etc. They might be accepted as a medium of exchange or payment, but, as of now, they do not have a legal tender status in any jurisdiction.

Digital, Virtual, and Crypto Currency

Digital currencies saw an incredibly steep growth in the last few years, with popular digital coins growing in value and versatility. These currencies are all part of a hierarchy of terms, but most commonly refer to them as cryptocurrencies. Essentially, cryptocurrencies are a type of virtual currency, which is a subset of digital currency. Virtual currencies are not regulated by a central bank which is why its value tends to fluctuate so drastically. They are bought and sold in a blockchain network to ensure security.

Cryptocurrencies are secured by cryptography to assure transactions are secure. Coins or currencies that are part of crypto have larger value because they are authentic and can be safely traded. As such, anyone can begin learning about cryptocurrencies and get involved with buying and selling them. 

Most taxpayers invest in crypto as if they are stocks. With the exponential increase in value over the years, virtual coins like Bitcoin have seen more than 10,000% increase over the last five years. Virtual currencies often have tax consequences that may result in a tax liability when traded. Like stocks or other investments, these transactions are often assessed tax only when traded. If you sell crypto in 2020 at a capital gain or loss, you will want to report it on your 2020 tax return. There may be tax deductions if you lose money on this while a gain would be taxed as income. eFile.com will handle this all for you and help report any of your virtual currency information on your tax return.

Virtual currencies can either be centralized or recentralized. The centralized currency, such as XRP, has a central administrator who is typically the issuer of the currency. This is similar to how a central bank is the central repository to a regulated currency. As such, a decentralized currency is the opposite; there is no third party or bank and transactions go through a separate system.

Virtual currencies are traded and exchanged digitally between buyers and sellers of the currency. Read more here about what to consider when selling virtual currencies. See more detailed information on regulations to persons administering, exchanging, or using virtual currencies.

Virtual Currency and Taxes

A virtual currency is treated as property, thus it is treated as a property transactions. As a result, it is not treated as a currency that could generate foreign currency gain or loss. See information on FinCEN FBAR Report 114.

If a virtual currency is used to pay for goods or services, it is treated as U.S. dollar fair market value for tax purposes. See Publication 525, Taxable and Nontaxable Income and exchanges involving property or services. Plus, Publication 551 regarding the Basis of Assets for computing of the cost basis value. The fair market value of a virtual currency in U.S. dollars is based on the date of payment or receipt.

For example, if a virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has to report a taxable gain. This is also the case if there is a gain or loss in exchange of virtual currency for other property, like real estate. See more information about the sales and other dispositions of assets.

If a taxpayer mines a virtual currency, the virtual currency fair market value is set as of the date of receipt of gross income. See more information about taxable and nontaxable income.

If you make charitable donations with virtual currency, then the donation is treated as a noncash contributions equal to the fair market value of the currency at the time of donation.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. This can be anything like a payment for performing work or services and receiving virtual currency as payment. For example, if a person makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services, they required to report that payment to both the payee or recipient and the IRS via Form 1099–MISC. You can include this form when you prepare your 2020 return on eFile.com.

Payments of virtual currency need to be reported using in U.S. dollar based on the fair market value of the virtual currency as of the date of payment as outlined above.

When you prepare your return on eFile.com, you will be asked if you bought, sold, or received any form of virtual currency during the tax year. Be sure to answer this question accurately and honestly and the eFile Tax App will help you report this, as well as other investments you may have, on your tax return. Tax Tip: if you only virtual currency transactions were purchases that were made with with real currency, you do not have to answer yes to this question.

See how the eFile platform works and compare us to other popular tax preparation platforms.

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