Virtual Currencies, NFTs, and Income Taxes
You can report virtual currency transactions for your tax return on eFile.com; start for free. The IRS requires a check in the Yes or No box for a question regarding certain investments, including digital currencies. If you made any transactions involving a virtual or crypto currency, you would need to select Yes.
A transaction involving virtual currencies can be:
- Sending or receiving virtual currency in exchange for goods or services
- Receiving or transferring virtual currency for free which does not qualify as a bona fide gift
- Acquiring a new virtual currency after mining, staking, or as a result of a hard fork
- Exchanging or trading virtual currency for another virtual currency
- The sale of a virtual currency
- The disposition of any financial interest in virtual currency.
If you partook in any of these, you should select Yes on eFile.com when you are asked if you made any exchanges of virtual currency. This is because the Form 1040 specifically asks if the taxpayer sold or exchanged virtual currency during the year. You can report your virtual currency exchanges or sales under the investments tab and they will be generated on Form 8949 and Schedule D - eFileIT. Virtual currency you received in exchange for service or goods should be reported as the income type it was received for - for example, if you were paid in a digital coin for freelance or gig work, then you would report this as freelance or self-employment work under the Business section. eFile will report this on your Form 1040 and Schedule C or Schedule 1 as applicable - eFileIT.
On this page:
- Digital, virtual, and cryptocurrencies defined - is Bitcoin a crypto or virtual currency? What's the difference?
- Adding virtual currency transactions to your income tax return.
- Sales of virtual currencies produce taxable events which are taxed as investments.
- NFTs are taxed similarly to virtual currencies but may be considered collectibles when trading or selling.
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, or 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.
How to Add Crypto or Virtual Currency Income to Tax Return
These sales are treated the same as when you trade a stock or sell any other asset. You should receive a 1099-B for your sale which can be added to your return. When you file your taxes using your eFile account, you will add this income under the Investments tab and eFile will generate the required forms, including Schedule D, and eFileIT.
Not sure when to report virtual currency transactions on your 1040 tax return? The latest IRS Form 1040 asks this question, updated to include specifications to alleviate confusion:
"At any time during [tax year], did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?"
This is simply asking if you sold or received a digital asset, such as a virtual currency. When you file your taxes online through your eFile account, you will be asked this question. How you answer it depends on your involvement with exchanging virtual currencies or digital assets. Refer to this table below on common situations to help determine how to answer this question.
You held virtual currency in your wallet or account.
You transferred virtual currency between one personal wallet or account to another.
You purchased virtual currency using a real currency which includes purchases made through a third-party platform like PayPal.
You engaged in any holding, transferring, or purchasing of virtual currency through your own accounts where another party was not involved and no sales were made.
You sent or received virtual currency in exchange for services and/or goods; you received or transferred a virtual currency for free which does not qualify as a bona fide gift; you acquired a new virtual currency after staking, mining, or from a hard fork; you exchanged or traded one virtual currency for another virtual currency; you sold virtual currency; you disposed of any financial interest in virtual currency.
The IRS Form 1040 for 2020 and 2021 asked the same question:
"At any time during 2021/2020, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?"
For these years, this is a checkbox on the Form 1040 which needs to be checked Yes or No.
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.
Virtual currencies can either be centralized or decentralized. 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 and other assets. See more detailed information on regulations to persons administering, exchanging, or using virtual currencies.
Most taxpayers invest in crypto as if they are stocks, often in order to invest or generate passive, unearned income. With the exponential increase in value over the years, virtual coins like Bitcoin have seen more than a 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 sold crypto at a capital gain or loss, you will want to report it on your income 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 or Crypto Currency and Taxes
A virtual currency is treated as property, thus it is treated as a property transaction when it is disposed or sold. 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 and 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.
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, including examples. If you make charitable donations with virtual currency, then the donation is treated as a non-cash contribution 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 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 and other investments you may have on your tax return. Tax Tip: if your only virtual currency transactions were purchases that were made with real currency in U.S. Dollars (USD), you do not have to answer yes to this question.
NFT - What Is It?
NFTs and Taxes
NFT is an abbreviation for non-fungible token. An NFT is a digital certification that grants one the ownership rights of a blockchain - most commonly, Ethereum (ETH) - which has its own unique value. In other words, an NFT is a digital piece of property one can buy and own which cannot be duplicated. Trading and investing in NFTs becomes complicated due to this. Unlike virtual currencies, where trading one Bitcoin for another Bitcoin is simple as the value fluctuates and each coin is the same value, a specific NFT cannot be traded for another as they are one of a kind. NFTs are generally purchased via Ethereum or other crypto through a third-party platform, but some may offer the option to buy with a credit or debit card.
Examples of NFTs include the popular selling of the first Tweet ever made which was purchased for $2.9 million, a digital piece of original art or history, digital trading cards, or an online essay. The purchaser receives the digital product as well as all the rights to the property. A simple way of understanding it is this: anyone can look up a picture of the Mona Lisa and print it out, but it will not be authentic. An NFT is a digital original that can not be copied.
NFTs and Taxes
NFTs are in a complicated place as their popularity has only recently grown. The IRS has started to provided official guidance on the taxation of NFT sales or exchanges in stating that they are treated as collectibles. When it comes to income taxes, you may pay taxes on gains or profit from the sale of a collectible. This is similar to buying a baseball card, pieces of art, antique cars, or other items that hold or increase value over the year. When the sale occurs years later, you may sell the item for more than you paid for it, resulting in a capital gain. This is the same concept as buying an NFT and later selling it for a profit.
In short, NFTs may be treated as collectibles if the right or asset of it can be defined as a collectible in the tax code. As an examples, gems are collectible according to the tax code, so an NFT which certifies ownership of a certain gem is considered a collectible.
Since NFTs are often purchased with cryptos, they are taxed similarly. This is because they can be used in exchanging cryptocurrency. Most exchanges of NFTs include selling the NFT for a cryptocurrency, buying an NFT with a cryptocurrency, and trading an NFT for a different NFT. Consider the following when creating, buying, selling, or trading a non-fungible token:
Creating, Selling an NFT
If you create and sell your own NFT - for example, as an artist, you draw your own original avatar and sell it online on sites like OpenSea - then the income from this exchange would need to be reported on your income tax return. You will owe tax at your ordinary income tax rate, but will also owe self-employment taxes as creating and selling your work is considered self-employment work. This is not a capital gain as you did not invest in the NFT, you instead created and sold a piece of property.
Investing, Trading NFTs
The process of purchasing an NFT can be boiled down to purchasing Ethereum (ETH) with your money in order to build a digital wallet. Then, purchase the NFT using the Ethereum. You then own the NFT; this is similar to buying a stock and the tax treatment of the NFT is like owning a stock.
The tax implications in this instance are dependent on the gain or loss on the Ethereum as well as how long the NFT was held. If the ETH you used to purchase the NFT is appreciated or has gone up in value since you purchased it, you would owe capital gains tax. If you held the Ethereum for over a year, you would owe long term capital gains (for less than a year, you would owe short term gains tax). If, however, your ETH was depreciated or you lost value, then you would report a loss which may lower your tax liability.
In selling an NFT, there are two ways to do this: sell an NFT for a different NFT or sell for cryptocurrency. When you trade one NFT for another, this transaction is treated as a capital gain or loss as well. This is determined by whether or not the NFT you sold was less valuable than the one you purchased. In other words, if you acquired an NFT valued at $5,000 by selling an NFT you owned at $4,000, then you would be responsible for a gain of $1,000 and be taxed on this. When you sell an NFT for crypto, you will incur a gain or loss. If you sell an NFT worth $2,000 ETH and sell it three years later for $6,000, then you have a capital gain of $4,000.
How an NFT is Taxed
Currently, the IRS has not provided formal guidance on the tax treatment of NFTs. It is likely that NFTs will be treated similarly to cryptos in that they will be taxed as capital gains in losses since they are property. Long term gains rates are anywhere from 0-20% of the sale of the asset or property. However, since the IRS has suggested NFTs may be treated as collectibles, this would subject them to the collectibles tax rate of 28%, regardless of income. If the sale or trade took place within a year for a profit, this is treated as a short-term gain and would be taxed at your ordinary tax rate for income.
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