Investors at every level are buying cryptocurrencies these days. There are several reasons you may have put some real dollars into cryptocurrencies. Maybe you are unsure of an overheated securities market, or you like the idea of removing money from traditional banks. Perhaps you’re just speculating on a new commodity. Since cryptocurrency is a viable payment option for many transactions, you need to keep track of all your crypto purchases for tax purposes. It’s a commodity that might have a veil of anonymity, but you still have to pay taxes on it.
How the IRS treats cryptocurrency
Regardless of why you’re buying digital money, the IRS wants its fair share come April or October. The agency has made the determination that crypto, or virtual, currency is a property like any other security and must be taxed as such. Some investors who are new to crypto trading are surprised to learn that these currencies are considered taxable currency by the IRS. They may assume that designation is reserved for hard currencies recognized as legal tender in a governmental jurisdiction.
When to pay taxes on virtual currency
There are two scenarios when taxes are owed on cryptocurrency. These scenarios include when someone uses it to buy or sell.
If you are paid for any goods or services via digital money, the amount paid is calculated in US dollars and added to your gross income. That amount is based on the conversion rate for that given currency to the dollar on the day you made the transaction.
If you use your digital currency to purchase anything, you should make a note of the conversion rate on the dates of those purchases. In the eyes of the IRS, you are disposing of an asset, and capital gains obligations come into play. Given the fluctuation of currency markets, your cryptocurrencies rise and fall just like euros or yen, so you are just as likely to gain or lose value.
Cryptocurrency is taxed like any other security
Most cryptocurrency investors don’t use it for transactions. Instead, they hold onto like they would any other equity. In this case, no taxes are due until the asset is sold. The tax rate you pay is just like any other sold asset and is based on how long you held the position. If it’s shorter than one year, you pay the short-term gain rate. If it’s longer than a year, the long-term gain rate kicks in.
This information goes on Schedule D and Form 8949 or Form 4797 on your return. You have to calculate the conversions on the form, so be sure to keep detailed records.
Cryptocurrencies in Massachusetts are a boon for the government. It’s one of three states that will not offer tax deferrals on reinvestments due to Covid, so owners have to reinvest within 18 months to avoid the capital gains hit.