IRS Reminds Taxpayers to Report Virtual Currency Transactions

Virtual Currency is Property for Tax Purposes

The IRS has issued guidance clarifying that virtual currency, such as Bitcoin and other cryptocurrencies, is treated as property for U.S. federal tax purposes. This means that transactions involving virtual currency may result in taxable events.

According to IRS Notice 2014-21, virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. It is not considered currency for tax purposes.

Taxable Events for Virtual Currency

Several types of virtual currency transactions may be taxable:

Sale or Exchange for Fiat Currency

When you sell virtual currency for U.S. dollars, foreign currency, or other property, you may have a capital gain or loss.

Trading One Virtual Currency for Another

Exchanging one type of virtual currency for another (such as Bitcoin for Ethereum) is generally a taxable event that may result in capital gain or loss.

Using Virtual Currency to Purchase Goods or Services

When you use virtual currency to buy goods or services, the fair market value of the virtual currency at the time of the transaction is included in your gross income.

Mining or Staking Rewards

Virtual currency received as mining rewards or staking rewards is generally treated as ordinary income at the fair market value on the date received.

Gifts of Virtual Currency

Gifts of virtual currency may be subject to gift tax rules, and the recipient may have carryover basis.

Reporting Requirements

Form 8949 and Schedule D

All virtual currency transactions must be reported on Form 8949 (Sales and Other Dispositions of Capital Assets) and summarized on Schedule D (Capital Gains and Losses) of your Form 1040.

Holding Period

The holding period for virtual currency begins on the date you acquire it and ends on the date you dispose of it. Assets held more than one year qualify for long-term capital gains treatment.

Cost Basis Tracking

You must track the cost basis of your virtual currency holdings. This includes the purchase price plus any associated fees. You may use various methods to identify which units were sold:

• FIFO (First In, First Out): Default method
• Specific Identification: Track specific units
• LIFO (Last In, First Out): Alternative method
• Average Cost: For certain qualified opportunities

Business Use of Virtual Currency

If you use virtual currency in your business or as an employee, different rules may apply:

Business Expenses

Virtual currency used to pay business expenses is deductible at the fair market value on the date of payment.

Employee Compensation

Virtual currency received as compensation is included in gross income at the fair market value on the date received.

Inventory

If you are in the business of buying and selling virtual currency, it may be considered inventory and subject to different accounting rules.

Foreign Virtual Currency Transactions

Transactions involving foreign virtual currencies may have additional reporting requirements:

• Report foreign currency transactions on Form 8938 if they exceed certain thresholds
• Consider foreign tax credits for taxes paid to foreign governments
• Report foreign financial accounts on FBAR (FinCEN Form 114) if applicable

Penalties for Non-Compliance

Failure to report virtual currency transactions can result in significant penalties:

• Accuracy-related penalty: 20% of the underpayment
• Civil fraud penalty: 75% of the underpayment
• Criminal penalties: Up to 5 years in prison and fines up to $250,000

The IRS has increased enforcement efforts regarding virtual currency transactions, so proper reporting is essential.

Additional Guidance