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IRS Crypto Tax Guidance – Here’s What It Means

Updated: Nov 16, 2021

For the first time since 2014, the United States IRS recently released official guidance for crypto tax. The version of this guidance that came out in 2014 has long been viewed as being somewhat incomplete, particularly as the world of cryptocurrency has grown more complex. And while the updated overview from the IRS may not be entirely comprehensive, it tells us a lot more about how crypto users may be taxed moving forward. Here, we’ll briefly dig into some of the specifics of the report about the new IRS crypto tax guidance.


IRS Crypto Tax: Hard Forks & Taxable Income

As the cryptocurrency industry has expanded and branched out, one of the issues with the 2014 tax guidance that has become clear is its failure to adequately address hard forks.

A hard fork can be described as an occurrence when a cryptocurrency and its distributed ledger split. This results in an entirely new cryptocurrency and blockchain. In other words, a hard fork is when blockchain developers use an existing cryptocurrency’s blueprint to spawn another similar one. In some cases, a hard fork can result in holders of the original cryptocurrency actually being given tokens representing the new cryptocurrency – which is now to be treated as taxable income. However, if you’re a holder of a cryptocurrency that undergoes a hard fork and you do not receive or gain control over any new cryptocurrency, you are not liable for any new income. Arguments have already been made that this, too, is an inadequate solution to the hard fork issue. In particular, many have taken issue with the notion that hard fork-related income is to be taxed based on the assets’ “fair market value” – whether or not the tokens can be spent anywhere, and whether or not the taxpayer wanted them in the first place. So, while there is more clarity now than there was previously, there are still legitimate questions about IRS policy.

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Taxes on spending crypto on products

Crypto tax concerning spending are addressed in the 2019 IRS guidance in a similar manner to what was laid forth in 2014. However, it’s important to make note of this category anew simply given the ongoing potential of prominent cryptos in mainstream spending applications.

Just last year, reports cited by FXCM indicated that there is still reason to believe cryptocurrencies could become “a mainstream form of payment” within the next 10 years. If these reports concerning mass adoption prove accurate, it could mean millions of people will need to learn how taxation works with regard to crypto spending. Essentially, the guidance from the IRS also makes clear (as it did for the most part in 2014) that spending cryptocurrency on goods and services can result in taxation if the value of that cryptocurrency at the time of the purchase exceeds what it was at the time of acquisition. In other words, if you can buy twice as much with one bitcoin as you could have at the time when you first acquired that bitcoin, and you choose to spend it, that transaction is taxable under capital gains rules (which are explained below).


Taxable Gains

In this regard too, a lot of the new guidance echoes what was set forth in 2014. However, it’s still important to make note of policy here, because ultimately taxes on cryptocurrency investments are what most crypto enthusiasts care most about. Many crypto holders are ultimately hoping for gains in this arena – particularly where bitcoin is concerned, given the example of the 2017 boom. Essentially, the IRS guidance still treats cryptocurrencies as property, rather than as currency, which means gains based on investment are categorized as capital gains. This means a similar calculation to other capital gains taxes is needed.

To calculate capital gains, you have to first figure out your cost basis and then subtracting this value from the fair market value at the time at which you “cashed in.” Per a guide from Cryptotrader, cost basis as applied to cryptocurrency is the price you pay (including transaction fees), divided by the quantity of cryptocurrency you are acquiring. What’s new regarding all of this – or what’s been clarified, at least – is that the IRS has issued instruction for how crypto users are to determine the price at the initial time of acquisition. Direct records can be use if thee crypto user can prove which specific assets (as in which crypto tokens) have been sold. Otherwise, trusted sources can be used to determine price based on the closest approximation of the date and time at which the initial purchase occurred. This covers the most significant aspects of the new official guidance from the IRS. All in all, it’s clear that steps are being taken to account for the rapidly expanding world of cryptocurrency. At the same time however, most cryptocurrency thought leaders seem to believe that the IRS is still in need of greater understanding of and better solutions for these issues – particularly when it comes to hard forks.

Article contributed by Linda Dennison


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Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.


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