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You may have heard that people are making a fortune trading in Bitcoin and other cryptocurrencies. But it may not all be easy winnings when you eventually begin investing in virtual currencies. You may make a profit or a loss, depending on the state of the market.
Whatever the case, you need to ensure you report your transactions are per the requirements of the Internal Revenue Service (IRS). You don’t want to be found guilty of not reporting your income to avoid paying taxes.
It could lead to you having to pay some hefty penalties or even doing some jail time. If you don’t know how to report your crypto dealings, here are some tips you can use:
Cryptocurrency Isn’t Money
With the new Form 1040 explicitly asking you to declare whether or not you have virtual currencies, there is no room for feigning ignorance of cryptocurrency tax. When it comes to taxes, cryptocurrency is not conventional currency, or even a security, but an asset that can either appreciate or depreciate.
If the currency appreciates, you will be liable to pay capital gains tax when you sell it. If you make a loss, you need to declare this as a capital loss so that the IRS knows you don’t owe them.
Mining Is Money
Cryptocurrency mining is verifying cryptocurrency transactions and updating the Blockchain digital ledger. Miners have the task of decrypting the information about a transaction contained in a block using given algorithms. Once they have done this, they will be able to authenticate the transaction and append it to the Blockchain.
For this service, miners earn a commission, which is usually also paid in cryptocurrency. The difference between the commissions earned and the costs a miner may incur in terms of internet connectivity and electricity bills is the miner’s profit. The IRS considers this profit as ordinary income for which income tax is due.
Pay Attention to Hard Forks and Airdrops
Some cryptocurrencies exist because of ideological differences within the team that created a cryptocurrency. Part of that team left and went on to create their own crypto. Such a split is called a hard fork. An airdrop is a rare event when a new cryptocurrency launches and its owners issue free tokens to promote it.
The IRS recently ruled that a hard fork without any airdrop is not a taxable event as it does not result in any income. However, in a case where a cryptocurrency does a hard fork and the owners of the new chain airdrop tokens, the airdrop’s beneficiaries may make a profit. If you’re one of them, you need to declare this income.
In the event you sell those tokens at a profit, the IRS will consider this taxable income that should be declared and subject to cryptocurrency taxes.
Theft is Costly
Unfair as it may sound, losing your crypto coins or tokens does not exempt you from paying tax on them. Previously, if you reported the loss of your Bitcoins or Altcoins as a theft loss, you could be exempted by the IRS. However, the tax authority has done away with such exemptions. In addition to bearing with the loss of your coins, you will have to pay tax on them.
And that’s not all. Before the tax law changes in 2018, you could trade digital currencies with other crypto users without taxation. But under the new rules, such like-kind trades will no longer be categorized under personal goods exchanges, which are not considered taxable. They are now real property for which relevant taxes will apply.
Keeping Up With Crypto Regulation
As you contemplate diving into the crypto world, it’s crucial to you apprise yourself of what the IRS requires of you. First, you need to be careful to have a good record of your crypto transactions for the time you need to declare them.
Second, you need to know the category of tax under which your digital currency transactions fall. Be sure not to overlook any source of income, even commissions earned as a cryptocurrency miner.
Knowing the IRS’s current stance on cryptocurrency transactions is not enough. Keep tabs with any changes that may occur in tax law in the future as far as they affect your virtual currency dealings. Cryptocurrency is still a new field, and the government is still getting a handle on the various avenues folks make a profit from it.