It’s tax time again, but this year it’s time to wonder about one of the newer mysteries of life: The tax implications of cryptocurrencies. For those with clients who have yet to engage in these assets this might only be a point of curiosity. But for many advisors, your clients are already there. So, is crypto taxable? Like a lot of topics related to tax, the short answer is ‘it depends…’ And this is not a tax issue for your clients to tackle on their own.
Failure to report transactions carries the risk of interest, penalties and possibly criminal charges. While the IRS can typically take three years to audit a return, if they can prove fraud there is no time limit.
Clients should also remember that they aren’t the only ones with information about their actions. Whether it is from whistleblowers or from John Doe summonses served on exchanges, the likelihood that activity will go unreported is unlikely.
Your clients may be doing crypto as a business through staking, lending, or mining. They might also be involved in airdrops or forks.
Read the Fine Print
Yes, it’s true that the IRS Form 1040 for 2021 includes the question “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” This question first appeared on the 2020 form and is reflective of the agency’s emphasis on compliance with the reporting obligations.
The IRS considers virtual currency to be property and the reporting requirements stem from this classification. This is an emerging issue, and the guidance is likely to change over time.
For taxpayers who choose to buy and sell crypto on an exchange, transaction records from these platforms can serve as the starting point for determining gains or losses. These transactions will be the easiest to report as they are the most straightforward. Other types of transactions that involve earning rewards paid in crypto will require more diligence on the part of the investor to track since they won’t generate a report similar to what buys and sells do on an exchange. Using crypto to make purchases is reportable because the purchase is a sale of the currency. So, I’ll have a coffee while I think about the tax reporting …
Additional Reading: The World Tips to Crypto Because of Global Sanctions Against Russia
Recordkeeping Required
It wasn’t that long ago that guidance on the IRS website specifically listed game currency from Fortnite as reportable. While this has been removed, it would be logically consistent to require the reporting. If a person pays $10 for an in-game currency and then uses it to purchase $15 of items, the $5 difference is a gain. Gaming companies are not likely to start issuing tax forms to users any time soon so it would be up to the player to keep records to support the positions taken on their return.
The examples listed here are only a small sample of what our clients may be doing with crypto. As advisors, we should take care to make clients aware that reporting obligations exist and have them work with a qualified tax preparer with experience in this area.
John M. Gehri, CFP, ChFC is an advisor with Harvest Financial Advisors in the Cincinnati/West Chester, Ohio area. He may be reached at john@harvestadvisors.com. This article is for informational purposes only. Any commentary and third-party sources are believed to be reliable but Harvest Financial Advisors cannot guarantee their accuracy.
