As cryptocurrency becomes increasingly common, the IRS is recognizing it as ‘property’ and formulating tax laws and regulations. Knowing these laws is essential to ensure accurate calculation of tax liabilities.  Both topics will be covered next. 


Basis of Assets-Publication 551


    IRS Publication 551, known as the Basis of Assets, talks about the value of the taxpayer’s investments to evaluate their tax liability. This amount or value is what is known as the basis. Cryptocurrency is classified as a property by the IRS- and not as a currency or security. Thus, the regulations and laws laid as part of the Basis of Assets apply to all cryptocurrencies like Bitcoin, Ethereum, etc. 


Cost basis for a cryptocurrency: Concept


    The taxable cost of a property is its basis. For a cryptocurrency (referred to as virtual currency by the IRS) the cost basis is the amount in US Dollars spent for its acquisition. 


    This cost basis also includes commissions, fees, and any other costs that may be included in the acquisition of the virtual currency. As per Publication 551, the following costs can be included while calculating the basis:


  • Freight

  • Sales Tax

  • Excise Taxes

  • Testing and installation

  • Account and legal fees

  • Recording Fees

  • Revenue Stamps 

  • Real estate taxes 

 

A lot of these may not apply to a cryptocurrency, since Publication 551 deals with all types of property and not just cryptocurrencies. 


Calculating the cost basis for cryptocurrencies


    The cost basis for a cryptocurrency would be the amount paid for its acquisition. This is generally equal to the fair market value of the virtual currency when acquired, at a specific date-time. The time and fair market value of the cryptocurrency on the day it was credited to the taxpayer’s account must be recorded.


    If the value increases or decreases when the cryptocurrency is sold for cash or exchanged for another virtual currency, there may be additional liability in capital gains/losses. This, again, depends on how it was acquired and the duration for which it was held. The framework is defined in Publication 544 of the IRS,.



Sales and Other Dispositions of Assets- Publication 544


    As the name suggests, Publication 544 (Sales and Other Dispositions of Assets) talks about what happens when any property, including a cryptocurrency, is disposed of. For a cryptocurrency, the specific events that are relevant for Publication 544 include:


  • Selling cryptocurrency in exchange for US Dollars

  • Exchanging cryptocurrency for another cryptocurrency

 

There are 4 things that are relevant for determining the tax basis, which are:


  1. Calculating loss/gain

  2. If gain or loss is ordinary capital

  3. Gain or loss in the case where the business property is disposed of

  4. Reporting gain or loss in the tax return 

 

Calculating loss/gain on cryptocurrency transaction


This has already been covered in detail in the earlier section- the difference in the Fair Market Value on the day of acquisition and disposal is the gain (if the value increased) or loss (if the value decreased).


Is it gain or loss of ordinary capital?


    If the cryptocurrency is held for one year or less before exchanging or selling it, it is a short- term capital gain or loss. Otherwise, it falls under long-term capital gains. 


    The holding period starts from the day the cryptocurrency gets credited into the taxpayer’s account, i.e. the day from which they have control to dispose of it (exchange, sell, or use for a purchasing a service/product). This holding period ends the day it is sold/exchanged. 



Gain or loss in the case where the business property is disposed of


    This part deals with cases where the business property is disposed of. (sold/exchanged) Any gains or losses that are made in such transactions are not part of the business schedule in the tax return. Any losses in such scenarios are fully deductible in the year when the sale was made. Gains are considered as ordinary income and additional gain is treated as short- or long-term capital gain depending on the holding period.

Reporting a gain/loss in the tax return


IRS Form 8949-D, used for reporting the disposal and sale of capital assets, is where all details of cryptocurrency transactions are to be filled.


Documents: Form 8949


    Once the capital gain and loss on all cryptocurrency (or virtual currency) transactions are calculated, Form 8949 (Sales and Dispositions of Capital Assets) is where they are reported. Every transaction involving crypto assets that were made in the reporting year must be included in this form. 


    The initial information at the top of the form is the first thing to be filled. After that, the taxpayer needs to select either of the 3 checkboxes in Part I of Short-Term Trades. The options being:


  • A: transactions reported on 1099-B including basis and reported to the IRS

  • B: transactions reported on 1099-B including basis not reported to the IRS

  • C: transactions not reported to the taxpayer on 1099-B



C) is opted by most taxpayers, as crypto-exchanges do not furnish 1099-B. The following information must be provided about each transaction:


  • Description/ type of asset

  • Date of acquisition and selling/disposal

  • Proceeds (selling value)

  • Cost Basis

  • Adjustment to gain or loss

  • Gain or Loss

 

The total or aggregate of all transactions would be calculated at the end. These include:


  • Total Proceeds: Sum of all transaction sale costs

  • Total cost basis: Sum of all acquisition costs

  • Total adjustment to gain or loss if any.

  • Total Gain/Loss: Sum of all capital gain and losses.


SAME WILL APPLY FOR LONG TERM HOLDINGS ON THE NEXT PAGE:


Trends in the upcoming regulation


    Cryptocurrency is here to stay and it has been sensed by regulatory bodies. The IRS has established its policies as reference and benchmark for other regulatory bodies. It seems reasonable to understand the basic framework established by the IRS to become a profitable crypto trader and avoid further liabilities. Crypto tax software is available in the market, assisting the taxpayer in the generation and filing of tax reports diligently. An accountant can help to review and manage taxes alongside the efficient crypto tax software.