IRS Answers Frequently Asked Questions About Virtual Currency Transactions
The IRS has released additional guidance on the tax treatment of virtual currency transactions in the form of Frequently Asked Questions (FAQs). The newly released set of FAQs address various virtual currency topics for taxpayers who hold virtual currency as a capital asset.
Background. In Notice 2014-21, 2014-16 IRB 938, the IRS explained what virtual currency is, how convertible virtual currency (like Bitcoin) has an equivalent value in real currency, and that cryptocurrency is a type of virtual currency that uses cryptography to digitally record transactions on a distributed ledger. In Notice 2014-21, the IRS explained that virtual currency is treated as property for federal income tax purposes and provided examples of how longstanding tax principles applied to transactions involving virtual currency. See "IRS details tax treatment of virtual currency (such as Bitcoin) as property".
On October 9, 2019, the IRS issued Rev Rul 2019-24, 2019-44 IRB, which addressed common questions regarding the tax treatment of a cryptocurrency hard fork. See "IRS issues additional guidance on virtual currency transactions".
New guidance. The newly released FAQs address various virtual currency topics for taxpayers who hold virtual currency as a capital asset. The new FAQs expand upon the examples provided in Notice 2014-21 and apply the same tax principles to additional situations. They note that:
- A taxpayer selling virtual currency must recognize capital gain or loss on the sale (FAQ 4), and virtual currency received in exchange for performing services is ordinary income. (FAQ 8)
- A taxpayer receiving virtual currency in exchange for performing services must report income equal to the fair market value of the virtual currency (in U.S. dollars) when received. In a cryptocurrency transaction that occurs on the blockchain (an on-chain transaction), virtual currency is received on the date and time the transaction is recorded on the distributed ledger. (FAQ 11)
- In an arm’s length transaction, a taxpayer’s basis in virtual currency received in exchange for services is the fair market value of the virtual currency (in U.S. dollars) when the virtual currency is received. (FAQ 12) The basis of property exchanged for virtual currency is the fair market value of the property at the time of the exchange. (FAQ 17)
- When exchanging property for virtual currency, the gain or loss is the difference between the fair market value of the virtual currency when received and the adjusted basis of the property exchanged. (FAQ 19)
- The fair market value of virtual currency obtained through a cryptocurrency exchange is the amount that is recorded by the cryptocurrency exchange for that transaction in U.S. dollars. (FAQ 25)
- The fair market value of virtual currency obtained through a peer-to-peer transaction ( not through a crytocurrency exchange) is the fair market value of the cryptocurrency on the date and time the transaction was recorded on the distributed ledger (on-chain transaction) or, if the transaction is not recorded on the distributed ledger (off-chain transaction) when the transaction would have been recorded on the ledger if it had been an on-chain transaction. (FAQ 26)
- Taxpayers can use a cryptocurrency or blockchain explorer (a web browser that is used to track virtual currency transactions) to substantiate the fair market value of virtual currency (explorer value). Taxpayers who don’t use an explorer value must establish that the fair market value they used to report their virtual currency transactions is an accurate representation of the cryptocurrency’s fair market value. (FAQ 26)
- When selling or exchanging virtual currency, taxpayers with multiple units of virtual currency that were obtained at different times and that have different basis may choose which units of virtual currency were sold, exchanged or otherwise disposed of if they specifically identify which unit or units of virtual currency were involved in the transaction and substantiate the basis in those units. (FAQ 36)
- A specific unit of virtual currency can be identified either by documenting the specific unit’s unique digital identifier such as a private key, public key, and address, or by records showing the transaction information for all units of a specific virtual currency, such as Bitcoin, held in a single account, wallet, or address. This information must show
- The date and time each unit was acquired,
- The taxpayer's basis and the fair market value of each unit at the time it was acquired,
- The date and time each unit was sold, exchanged, or otherwise disposed of, and
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit. (FAQ 37)
- Taxpayers who do not specifically identify units of virtual currency that are sold, exchanged or otherwise disposed of, are deemed to have sold the units on a first-in-first-out (FIFO) basis. (FAQ 38)
- Capital gains and losses from virtual currency transactions are reported on Form 1040, Schedule D and Form 8949, Sales and Other Dispositions of Capital Assets. (FAQ 40)