Whether you're a long-time crypto investor or someone who recently purchased digital assets, here are some important things you need to know from a crypto tax expert.
How to answer the “Digital Assets” question on Form 1040
Virtual currencies have become a priority area for the IRS, which in January shared guidance on reporting digital currencies this tax season.
Starting with the 2019 tax year, the IRS has collected cryptographic data on tax returns that include different versions of “yes” or “no” questions. For 2023, there will be a “Digital Assets” question on the cover page of Form 1040, as well as estate, trust, partnership, corporation, and S corporation returns.
But many crypto investors don't realize that the term “digital assets,” which includes virtual currencies, stablecoins, non-fungible tokens, etc., applies to them, says MDM Financial Services owner said one registered agent, Matt Metras.
If you sold your cryptocurrencies in 2023, you should answer “yes”. Exchanged one coin for another. or if you receive digital currency as a payment, reward, or prize in accordance with the instructions on Form 1040. If you bought cryptocurrencies with USD and still own the assets, you can answer “no”.
“Yes” or “no” questions are very powerful.
andrew gordon
President of Gordon Law Group
“Yes-or-no questions are very powerful,” says Andrew Gordon, a tax accountant, CPA, and president of the Gordon Law Group.
According to Gordon, if you have profits or income from cryptocurrencies and you answer “no” to the digital assets question, the IRS could argue that you “willfully” violated the law.
However, he said the 2023 digital asset issue does not apply to Bitcoin futures ETFs or spot Bitcoin ETFs.
How to calculate cryptocurrency tax
If you trade or sell digital currencies for a profit, you may be subject to capital gains or ordinary income taxes, depending on your “holding period” or how long you owned the asset.
“They are treated like stocks or other real estate,” and the gain is the difference between the “base,” or purchase price, and the value at which the asset is sold or exchanged, Gordon said.
If you hold cryptocurrencies for more than a year, you will be eligible to receive long-term capital gains of 0%, 15%, or 20%, depending on your taxable income. In contrast, short-term capital gains or ordinary income taxes apply to assets owned for less than one year.
Both categories use “taxable income.” It is calculated by subtracting the greater of your standard deduction or itemized deductions from your adjusted gross income.
For high-income earners, Gordon said it's critical to track the date of purchase, as selling your crypto after a year could “cut the rate in half.”
How virtual currency tax reporting works
Many investors use tax returns to file their returns each year. But experts say the lack of reliable reporting is even more difficult for crypto investors.
For 2023, depending on the exchange, you may receive a Form 1099-MISC for compensation or income, a Form 1099-B for transactions, or no form at all.
Additionally, if you receive tax forms for your cryptocurrencies, you may encounter basis reporting errors if you move your currencies from one exchange to another.
The U.S. Treasury Department and IRS have announced proposed regulations that include a standardized Form 1099-DA for reporting digital assets for transactions on or after January 1, 2025.
In the meantime, crypto investors will need to report their activity based on their personal record-keeping, which Metras said could be difficult given the high volume of activity.
“Once you have more than five transactions, it becomes a pain to try to process it yourself in an Excel spreadsheet,” he said.
