According to Notice 2014-21 published by Internal Revenue Service (“IRS”), cryptocurrency such as bitcoin is treated as property for federal tax purposes. Therefore, general tax principles applicable to property transactions apply to transactions using cryptocurrency.
As cryptocurrency is treated as property, transactions using cryptocurrency can generate capital gain or loss. Here are some examples of taxable cryptocurrency events: (1) selling cryptocurrency for cash, (2) paying for goods or services with cryptocurrency (3) buying one cryptocurrency with another cryptocurrency (4) receiving mined cryptocurrency, and (5) being paid in cryptocurrency.
In order to calculate your taxable gain or loss from cryptocurrency, you have to determine your basis for cryptocurrency and fair market value of the property or service you received. The basis is the amount you spent to acquire the virtual currency, including fees, commissions, and other acquisition costs. For example, you bought one bitcoin at $10,000. After 11 month, you sold the same bitcoin to purchase a car at fair market value of $12,000. In this case, you must report your capital gain of $2,000 on form 8949 with your basis of $10,000, proceeds of $12,000. Those amounts will show on Form 1040 schedule D.
In order to decide which units of cryptocurrency are deemed sold, exchanged, or otherwise disposed of, you can use two methods. The first method is to identify a specific unit of virtual currency either by documenting the specific unit’s unique digital identifier such as private key and public key, or by records showing transactions information for all units of cryptocurrency. This information must show (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit. The second method is on a first in, first out (“FIFO”) basis. The units are deemed to have been sold, exchanged, or disposed of in chronological order.
Starting in 2020, people who have transactions using cryptocurrency will receive either 1099-K or 1099-B. If you receive 1099-K, the amount simply represents the gross proceeds from your reportable transactions but not the amount of taxes owed. Therefore, you will need to report those amounts on form 8949 with your basis to calculate correct capital gain or loss. On form 1099-B, every information you need to report your capital gain or loss will be given.
Written by Jay Jang
Edited by Kevin Jang