IRS TO UPDATE VIRTUAL CURRENCY QUESTION FOR 2021
On July 22, 2021, the IRS released the draft of Form 1040. The IRS has made an important change to the wording of the virtual currency question that was on the front of Taxpayer’s 2020 Form 1040: “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”
The new wording is anticipated to read, “At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in virtual currency?” This is an important change, as it narrows the scope of the information the IRS is acquiring, ostensibly to only require an affirmative answer by those taxpayers who may have an event involving virtual currency that will result in a reporting of taxable income or loss with respect to a transaction or transactions.
A recent study estimated that over 46 million Americans now own at least some portion of bitcoin, which translates to about 17% of the taxpaying public. The IRS is anticipating millions of returns with the new box marked yes. It is important to note that although the question is changing, the obligation to report crypto currency transactions is not changing.
So what is virtual or crypto currency? 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 does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.
If you use this currency in your business to pay for goods or services, you generally will have a gain or loss on the transaction equal to the value of the goods or services received less your basis in the virtual/crypto currency used to purchase these good or services. Generally, your basis is calculated on a first-in first-out basis, which can result in unintended gain consequences, especially if you purchased the currency when it was trading at a very low price.
For investment gain or loss calculations, on transactions concerning the sale or conversion (trading one type of crypto currency for another type, i.e. Bitcoin trade for Ether), the value at the time of sale or trade is the sales price less any fees, and your basis in the traded or sold currency is the amount you paid for it. The holding period for the virtual currency to determine long term or short term tax treatment is similar to other investments. Currency held over 1 year is subject to long term capital gain treatment, while less than 1 year is short term capital gain treatment.
Please contact us to discuss how we can assist in planning for your use of virtual currency in your business or investments.