Tax Considerations for Crypto Assets

Investors in the United States earned more than $4 billion in 2020 as interest in cryptocurrency took off and values surged. Despite volatile ups and downs in the market in 2021, cryptocurrency continued to pick up speed, with Bitcoin hitting a new record high of $68,000 in November 2021. While investors likely did their fair share of celebrating as they saw huge gains, the 2022 tax season is here to join the party. As people take a look at their 1040 tax forms, they will need to pay attention to the question asking about virtual currency transactions. 

Crypto assets are increasingly popular among investors and average Joes alike, but that doesn’t mean they are getting any easier to understand. When it comes to determining how to pay taxes on these assets, a CPA with knowledge of crypto technology can provide invaluable assistance for investors. As regulations continue to evolve concerning these assets, CPAs should be ready to provide expert tax planning and advice. Here are a few things CPAs should know about tax reporting of crypto assets.

Is Cryptocurrency Taxed?

Although cryptocurrency is not backed by any fiat currency, it is very much a taxable asset. Even before cryptocurrencies had explosive gains in 2021, the IRS had its eye on the technology. It issued guidance in Notice 2014-21 for reporting cryptocurrency transactions, and the agency reminded taxpayers in 2018 to include these transactions in their returns. What’s more, form 1040 was revised in 2021 to further emphasize reporting any gains from cryptocurrency. 

It’s clear use of this technology will continue to proliferate, and accurate reporting on tax forms is essential for people and businesses dealing in cryptocurrency. 

What Transactions Are Taxable?

The IRS treats cryptocurrency as property, and it is taxed as such. If a person receives cryptocurrency as payment for goods or services or through mining, it is treated as income. The value for income purposes is determined by the value of the currency on the date it is received. 

Cryptocurrency is also subject to capital gains and losses if it is held for a time before it is used: short-term gains for currency held less than a year, and long-term gains for currency held more than a year. These gains or losses are realized when the cryptocurrency is exchanged for cash, used as a payment, exchanged for other cryptocurrency, and other uses. Taxpayers must calculate the difference in value for the cryptocurrency when it is used from when it was received. For example, if a person buys or mines Bitcoin or Ethereum when the coins have a value of $350, and they are then used at a value of $750 or $1,200, those capital gains will be subject to a tax. 

Just having cryptocurrency doesn’t make it taxable. If cryptocurrency is purchased with fiat currency or given as a gift, it will not be taxable until it is used and subject to capital gains. If the cryptocurrency is donated to a charity before it is exchanged for cash, the taxpayer can also count the donation as a tax deduction by using the value of the currency at the time of the donation.

What About NFTs?

While cryptocurrencies like Bitcoin and Ethereum are some of the most common crypto assets, they are far from the only ones on the market. NFTs, or non-fungible tokens, are quickly emerging as options for investment or even collecting. NFTs made news in 2021 as popular YouTube videos and other items were sold as NFTs for millions of dollars. 

While they have become more widely known to the general public, NFTs are still not so easy to figure out for CPAs submitting tax forms. The IRS has not issued guidance on these assets, so CPAs are left to determine where they fit best. In many cases, NFTs are considered to be collectibles with a 28 percent tax rate on capital gains, as they are each unique and cannot be exchanged. If an NFT is classified as a collectible, it is important to determine whether its holder should pay tax on capital gains or if they are able to declare capital losses.

Avoid Surprises at Tax Time

Crypto assets are growing in popularity, and tax rules are still evolving to keep up. While some things may change over time, savvy CPAs can avoid major surprises for their clients when it comes time to square up with the IRS each year. You’ll need to stay up to date on tax rules and regulations concerning different kinds of assets to give clients an idea of what they will owe for their crypto assets. 

Crypto assets and their classifications can be confusing even for experienced accountants. CPAs should take advantage of continuing education focused on crypto technology to get a full understanding of how to accurately account for these assets on financial reports. 

In-depth financial reports give businesses the best look at their financial picture and sidestep major surprises come tax time. Accurate reporting of crypto assets is vital and can have an enormous impact on a client’s tax burden. For example, a client wishing to buy an NFT will need to prove their NFT purchases were made as an investment to take advantage of any capital losses. Detailed reporting of these purchases helps ensure taxes are filed appropriately.

As crypto assets gain popularity and become more widely used, knowledgeable CPAs will be critical allies for their clients. Understanding this technology is crucial for CPAs to provide tax planning and advice on issues that may arise.