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  • Writer's pictureNaila Sharifova, CPA, MST

Cryptocurrencies. Ready for Taxman?

February 7, 2022

As virtual currency has garnered its wide popularity among public, it has also captured the IRS’s attention in recent years. Form 1040 now requires a disclosure as to whether a taxpayer received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. So, what does it mean for you and which transactions should you keep track of for reporting purposes?

First, the good news. If your only transactions in virtual currency during the year were purchasing crypto for regular currency, there is nothing to report yet. If you experienced a soft fork and you did not receive any new crypto as a result, again there is nothing to report. Transferring crypto from one of your wallets to another is nontaxable either.

Meanwhile, if you had a hard fork event and ended up with a new crypto, you are to report it as ordinary income. Selling your services for crypto will result in ordinary income for you subject to self-employment taxes. Also, buying goods and services with crypto constitutes taxable exchange similarly to trading one crypto for another or just selling crypto.

The IRS considers virtual currency a property and for non-traders sale and exchange of crypto for another crypto or regular currency will result in exchange of capital assets subject to capital gains and losses.

While there is at least some IRS guidance as to the tax consequences of transactions involving cryptocurrency, nonfungible tokens (NFT) have received, so far, even less attention from the IRS, yet their popularity has recently exploded. In the meantime, while waiting for formal guidance for treating NFTs, general tax principles governing sale and exchange of intangible property will likely be the most sensible way forward.

Under those principles, an NFT in the hands of its creator will likely be treated as a self-created intangible asset whose basis is not subject to amortization. Meanwhile, purchase of an NFT will likely be governed by Sec 197 allowing a buyer to amortize the new property using the straight-line method over a period of 15 years. The above tax treatment will depend on whether the purchase of an NFT is for personal or business reasons.

Sale of an NFT by its original creator will likely constitute ordinary income, whereas sale of an NFT by someone other than an original creator will likely constitute capital asset sale generating capital gain or loss.

There is still lack of guidance from the IRS in regard to cryptocurrencies and NFTs, but applying general tax principles in the meantime will likely provide a reasonable method of accounting for digital transactions.

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