Cryptocurrency owners, beware: The IRS is trying to strip away excuses for millions of people who aren’t complying with the tax rules on them, either inadvertently or on purpose.
The agency has put a pointed question on the front page of the Form 1040, just below the taxpayer name and address. It first appeared on the 2019 tax return in a less prominent position and moved to its current place on the 2020 return.
On the 2021 return, the question has been reworded slightly: At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?
The tax filer must check the box “Yes” or “No.” Cryptocurrency owners who don’t answer the question or are untruthful risk higher penalties if the IRS audits them, as it will be hard to claim ignorance of the rules.
The agency also has other crypto enforcement efforts under way. In 2021, it persuaded judges in Boston and San Francisco to approve summonses requiring two cryptocurrency exchanges to turn over records for customers who had more than $20,000 in transactions in any year from 2016 to 2020.
The IRS says cryptocurrencies such as bitcoin are property
The IRS first released guidance on the taxation of cryptocurrencies in 2014. It said that bitcoin and other cryptocurrencies are property, not currencies such as dollars or euros. Often they are investment property akin to stock shares or real estate.
This means that if the crypto is held in a taxable account—as opposed to a retirement account such as an IRA or Roth IRA—net profits from a sale are typically taxed as long-or short-term capital gains, and losses can be used to offset gains.
This tax treatment has benefits, but also important drawbacks. If cryptocurrency is used to make a purchase—even of a sandwich—then the transaction typically generates a taxable sale of the crypto that the buyer must report to the IRS.
For example, say that Jack buys a boat with $10,000 of cryptocurrency that he purchased for $5,000. Jack’s transfer of the crypto is taxable. He has to report a taxable gain of $5,000 to the IRS—much as if he bought the boat with shares of stock that had grown from $5,000 to $10,000.
This makes cryptocurrencies a cumbersome substitute for cash.
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In 2019, the IRS issued more crypto guidance, including rules for how holders should treat cryptocurrencies if these undergo a reorganization that changes the network protocol of coins or results in the distribution of new tokens. It said that if a cryptocurrency owner receives something of value, then its fair market value is taxable at ordinary income rates when the taxpayer has control of it.
In late 2020, the Financial Crimes Enforcement Network (FinCEN), a Treasury Department unit separate from the IRS, announced it may require U.S. taxpayers holding more than $10,000 of cryptocurrencies offshore to file FinCEN Form 114, known as the FBAR, to report these holdings. This rule hasn’t yet been adopted, so it wasn’t in effect for 2021.
This year’s tax deadline for most individuals is April 18. Interested in knowing more before you file your taxes? Register here to read the WSJ Tax Guide 2022.
Write to Laura Saunders at Laura.Saunders@wsj.com and Richard Rubin at richard.rubin@wsj.com
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