Virtual Currency

The following question appeared for the first time on the 2019 tax return: “At any time during the tax year, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency.”   Taxpayers must indicate whether or not they engaged in virtual currency transactions by responding yes or no.  The tax return will not be accepted for e-filing or filing, period, if an answer to this question is omitted.  A response of “yes” to this question usually means you’ve triggered a taxable event from your virtual currency transactions, which must be reported on your tax return.

What is virtual currency?  The IRS defines virtual currency as “a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange.” 

USD dollar or foreign currency is known as real currency or fiat currency.  In the United States, the US dollar is backed by the US Government and is accepted as legal tender.  The US dollar is fiat currency.  As legal tender, the US dollar must be accepted when offered in payment of a debt or purchase.   

Virtual currency is a digital representation of value and functions as a medium of exchange, a unit of account and/or a store of value.  It operates very similar to real currency.  However, virtual currency does not have legal tender status.  It is not controlled or backed by the US Government like fiat currency.  It is available in digital form only unlike the US dollar.   

Virtual currency is spendable.  Virtual currency is transacted through certain software applications and digital wallets.  The IRS estimates that there are over 2,000 virtual currencies.  Some virtual currencies are convertible, which means they have an equivalent value in real currency or function as a substitute for real currency.  The tax rules apply to convertible virtual currencies, which can be converted in and out of US Dollars. Non convertible virtual currencies such as those that are purchased to play games on your phone, computer, or gaming console can only be used within the gaming system and can’t be converted back to US dollars.

Cryptocurrency

Cryptocurrency is a type of virtual currency.  It uses cryptography to record secure transactions digitally on a distributed ledger such as blockchain.  Bitcoin, Ethereum, Litecoin, and Ripple are popular types of cryptocurrencies.  Basically, blockchain is a technology that allows the ledger of transactions to be distributed to users.  Blockchain is a list or record of transactions that anyone can view and verify. The use case for crypto has expanded and evolved to an eco-system since Bitcoin first launched in 2009.

Tax Impact of cryptocurrency

For federal tax purposes, virtual currency is treated as property. Reporting cryptocurrency on your tax return is similar to reporting a stock sale or other reportable stock transaction. Report cryptocurrency transactions on your tax return when you:

• Earn it in exchange for goods or services (e.g. receive cryptocurrency as payment of a wage),

• Receive it (e.g. for free in the case of for free including from an airdrop or following a hard fork that created a new cryptocurrency),

• Sell it,

• Exchange it (e.g. for another virtual or cryptocurrency),

• Spend it (e.g. purchase goods or services),

• Convert it (e.g. to U.S. dollars or to another virtual currency),

• Otherwise acquire it (e.g. inherit).

This is not an exhaustive list.

As with any tax issue, contact your tax professional to help you navigate your own unique situation.

Listen to Practical Tax Talk Podcast to hear more information on this topic.