You may have noticed a new question on Form 1040 related to cryptocurrency when completing your 2023 taxes. Because cryptocurrency ownership is growing, the IRS added the question to alert folks that there are tax implications of owning cryptocurrency. Owning cryptocurrency is very similar to holding money overseas: It is perfectly legal, but must be included as part of your United States federal income tax return if you are a “U.S. person” for tax purposes (generally a citizen, national, or tax resident).
What is cryptocurrency?
Cryptocurrency—or just “crypto” by its shorthand reference—is a digital currency that is not issued or regulated by a central bank. It can be used to purchase goods and services (assuming the seller will accept it) or held as a speculative investment in hopes that its value will rise. Bitcoin and Ethereum are the most popular cryptocurrencies available, but there are scores of others as well. You can buy, hold, and sell cryptocurrency in much the same way you can buy, hold, and sell stocks, mutual funds, and foreign currency. For example, Coinbase is a platform used to invest in cryptocurrency just like Vanguard and Fidelity are platforms used to invest in stocks and mutual funds.
Coinbase is just one example of a cryptocurrency exchange. There are plenty of others, but Coinbase is the best I have seen from a tax-reporting perspective. (More on that below!)
“Digital assets” is a general term that includes cryptocurrency, non-fungible tokens (NFTs), and stablecoins. The tax principles that apply to cryptocurrency generally apply to other types of digital assets as well.
New cryptocurrency can be created through a process known as mining, where dedicated computers solve puzzles to verify cryptocurrency transactions in exchange for releasing new cryptocurrency into circulation.
Another way to earn cryptocurrency is through staking, where owners use their existing cryptocurrency (their “staked” tokens) to verify transactions. Not all cryptocurrencies allow staking, and there are risks involved.
How is cryptocurrency taxed?
The current tax landscape does not address cryptocurrency specifically. As a result, many cryptocurrency exchanges provide very little, if any, useful information related to tax reporting. But just because certain information might not be obvious or apparent does not mean you have no reporting responsibilities. After all, the tax code defines gross income as “all income from whatever source derived” unless specifically excluded.
If you are going to invest in cryptocurrency, pick an exchange that has strong information reporting. In my experience dealing with dozens of cryptocurrency owners, Coinbase currently does the best job in this area.
Answering the cryptocurrency question
The cryptocurrency question on the 2023 Form 1040 reads:
At any time during 2023, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?
If all you did was buy and hold, then the answer is no, and there are no tax implications. But be careful. If you exchanged one cryptocurrency for another, for instance, the answer is yes, and you have some additional reporting obligations.
Selling or exchanging
The easiest way to wrap your head around the tax implications of cryptocurrency is to think of it like a mutual fund or foreign currency. If you bought Bitcoin when it was selling for $17,000 per unit, and sold your entire holding when it was trading for $51,000 per unit, you would have a per-unit capital gain of $34,000 (i.e., $51,000 – $17,000) that would be classified as either short-term or long-term based on your holding period. If you bought or sold in several lots, tracking this is more complicated, but the same basic premise applies. Report these gains or losses on Form 8949. Check box C (for short-term holdings) or F (for long-term holdings) as appropriate.
Many folks throw money into a cryptocurrency exchange, trade cryptocurrency within that exchange, and assume there are no tax implications until they withdraw money from the exchange. That is incorrect. Be sure to track each type of cryptocurrency separately. For example, if you exchanged Bitcoin for Ethereum, you have effectively sold Bitcoin and purchased Eretheum. Use the same logic as if you sold stock in Amazon and purchased stock in Apple. You will need to track both sides of the transaction in their United States dollar equivalent at the time.
Assume you owned 0.5 Bitcoin when it was trading for $60,000 and Ethereum was trading for $3,000. Your 0.5 Bitcoin is valued at $30,000, which is the same as 10 Ethereum. In exchanging your 0.5 Bitcoin for 10 Ethereum, you have sold your 0.5 Bitcoin for $30,000 and will have a capital gain or loss on your Bitcoin holding relative to its purchase price. You have also purchased 10 Ethereum for $30,000, which is your basis in that Ethereum when you eventually sell or exchange it.
Mining and staking
The tax treatment of mining and staking is different from the tax treatment of buying and selling. While buying and selling is similar to trading stocks, mining and staking requires work, making the taxation a bit different.
Earning additional cryptocurrency from mining is like earning money from a side hustle, since it involves active effort on your part, and then buying more of that cryptocurrency. Treat income from mining like you would hobby income. Report it on Form 1040, Schedule 1, Line 8z in its United States dollar equivalent at the time you earned it. (If you earn 0.01 Bitcoin when it is trading at $60,000, that is $600.) Your description would be “cryptocurrency mining.” This value then gets added to your basis in that holding. (The 0.01 Bitcoin mentioned before has a $600 basis.) If your mining activity is significant enough that it is a for-profit business rather than a hobby, the income goes on Schedule C instead, and the net profit gets added to your basis in that holding.
Earning additional cryptocurrency from staking is like earning interest on a certificate of deposit, since you agree to lock up those funds for a specified time in order to earn more, and then buying more of that cryptocurrency. Treat income from staking like you would interest income. Report it on Schedule B, Part I in its United States dollar equivalent at the time you earned it. (If you earn 0.15 Ethereum when it is trading at $3,000, that is $450.) Your payer would be the name of your cryptocurrency exchange, and I suggest adding a brief description. For example, you might indicate “Coinbase (Ethereum staking award)” on your form. This value then gets added to your basis in that holding. (The 0.15 Ethereum mentioned before has a $450 basis.) Alternatively, you could report it as “other income” like mining, as described in the previous paragraph.
Payment for property or services
Finally, you might receive cryptocurrency as a payment for property or services. If you sell your truck for 0.6 Bitcoin when it is trading for $60,000, you have effectively sold your truck for $36,000 (0.6 × $60,000)—which may or may not have its own tax implications!—and used that money to purchase 0.6 Bitcoin. Your basis in that 0.6 Bitcoin is $36,000.
If someone pays you 0.6 Bitcoin for a landscaping project, you have effectively been paid $36,000 for that work (again, 0.6 × $60,000, assuming that is the going rate for Bitcoin at the time of payment), and then used that money to purchase 0.6 Bitcoin. Report the $36,000 of income accordingly (i.e., as wages or business income), and be sure to track your $36,000 basis in that 0.6 Bitcoin for when it is eventually sold or exchanged.
The reverse is also true: If you pay someone 0.6 Bitcoin for a landscaping project, you have effectively sold 0.6 Bitcoin for $36,000, and then paid them $36,000. Report both transactions accordingly.
Invest in cryptocurrency indirectly
You can also invest in cryptocurrency without purchasing it directly, by purchasing shares of a mutual fund that owns cryptocurrency. Fidelity, for instance, has various cryptocurrency offerings. Investing in a mutual fund through a broker such as Fidelity gives you exposure to the industry without having to stress over the cryptocurrency-specific tax nuances, since the broker handles all that for you and reports dividends and capital gains just like it would for any other mutual fund.
Investing in cryptocurrency is not for the faint of heart. Even casual, everyday investors have tax reporting requirements. If you are going to take the plunge, be aware of what is involved so you do not run into trouble with the IRS.
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