The IRS Wants to Know about Your Crypto
At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?
Cryptocurrency such as bitcoin is all the rage these days. Crypto is not legal money. It is property, similar to gold. Like gold, its use can result in taxable income.
The IRS is concerned that you and millions of Americans are using crypto without paying tax on the earnings. To clarify that it expects you and other taxpayers to report crypto earnings, the IRS added the following question about cryptocurrency to the top of Form 1040:
At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?
You must answer this question under penalty of perjury, even if you have never heard of bitcoin and don’t know what cryptocurrency is. You can’t leave the field blank.
Unfortunately, this is something of a trick question. It is so broadly worded; you’d think any transaction involving digital currency requires a “yes” answer. But that is not the case.
IRS guidance makes clear that it is interested only in virtual currency transactions that result in taxable income (or loss) that must be reported on a taxpayer’s return.
Thus, for example, if you simply use Robinhood to purchase Dogecoin using dollars from your checking account and hold that Dogecoin without exchanging or selling any of it during the year, then you can answer “no” to the crypto question. The same goes if you received crypto as a gift or transferred crypto from one wallet to another (not an exchange, but a transfer, AKA “send”). Purchasing cryptocurrency using dollars is like purchasing a car, a diamond ring, a stock share, a bar of gold, or any other asset. The purchase of an asset is not subject to income tax.
However, you should answer “yes” to the crypto question if you sold some crypto for dollars, exchanged crypto for another type of crypto (this is super common!), purchased or sold goods or services using crypto, received new crypto through mining or staking activities, or got new crypto from a hard fork. All these activities result in taxable income (or loss). The IRS sees this as disposing of an asset…which is NEVER for the exact same value as when you acquired it. There is ALWAYS a profit or loss for these type of transactions.
What should you do if you answered the crypto question wrong?
If you answered the crypto question “yes” when you should have answered “no,” you don’t have to do anything. There is no need to amend your tax return.
On the other hand, if you answered “no” when it should have been “yes” and you did not report your taxable virtual currency transactions, you need to file an amended or superseding return. If you fail to do so, you may get a letter from the IRS advising you to file an amended return and pay any taxes due. The IRS began sending out such letters in 2019 based on reports they receive from crypto exchange platforms like Robinhood, Coinbase, etc.
How can you track your crypto transactions for tax purposes?
The crypto exchange platforms (like Robinhood and Coinbase) do not track all possible transactions fully. Some platforms hold the raw data, but don’t put it in a usable format for tax return preparation purposes. Thus, for example, if you purchased Ethereum using Coinbase then transferred that same Ethereum into a wallet on Robinhood, Robinhood does not have the original purchase data from Coinbase and therefor cannot properly track the data required for calculating profit or loss when you sell or exchange that Ethereum. We highly recommend a Crypto Portfolio Tracker to manage all of your transactions across all of your exchanges and wallets. There are many good Trackers to choose from depending on your level of crypto activity. They will likely cost you a few bucks. Keep in mind, your tax preparer cannot do the tracking from the raw data for you at tax time. You should track your transactions carefully throughout the year.
Disclaimer: The mere mention of any crypto-related company or platform in this post is NOT to be construed as an endorsement for that company or platform. The information in this post is for tax-related education only, not trading advice. Your trading activity is at your own risk.
