The IRS has issued new guidance on the tax ramifications of virtual currency (cryptocurrency) transactions. The guidance follows the existing IRS position that virtual currency is property and not equivalent to a foreign currency. As such, transactions involving the sale, exchange, receipt, disposition or contribution of virtual currency may result in gain, loss, income or expense, and must be reported.
What the IRS Says about Cryptocurrency
Rev. Rul. 2019-24 deals with questions related to events found in cryptocurrency transactions such as a “hardfork” and an “airdrop.” The IRS has taken some positions that create the need for additional guidance and generates even more questions to be answered on the tax treatment.
Questions and Answers issued at the same time as Rev. Rul. 2019-24 confirm that the IRS expects the normal rules for transactions in property to be followed in the case of transactions in virtual currencies. The receipt of virtual currency in exchange for services is ordinary income subject to employment tax. The transfer of virtual currency in exchange for cash or other property is a sale with gain (if the fair market value of property received is greater than the taxpayer’s basis in the cryptocurrency) or loss (if the opposite is the case) required to be recognized.
Where a taxpayer owns multiple units of virtual currency that have been acquired at different times and have different basis, the Q&A provides that the taxpayer may specifically identify which units are the subject of the transaction. Specific identification may be done by documenting the unique identifier associated with the unit of virtual currency, or by use of records showing all the transactions for that type of virtual currency held in a single account. If specific identification is not possible or is not made, the units that are the subject of the transaction will be the earliest units acquired (FIFO basis).
Public statements by IRS officials indicate that examination of transactions involving virtual currency and the gathering of information to assist that examination is a priority. A draft of the 2019 Schedule 1 to Form 1040 includes the question, “At anytime during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
The IRS has also published Chief Counsel Notice 2020-003. This gives further focus and attention on the oversight from the IRS on the area of taxation in cryptocurrency.
Impact on Usage of Cryptocurrency
Anyone involved with virtual currencies should be alerted to these developments. Given the wide swings in value of some virtual currencies over the past several years, attention should be given to establishing sufficient records to allow for the specific identification of virtual currency units and the basis of each. Otherwise, arbitrary application of a FIFO approach could result in the unnecessary recognition of excessive capital gains or the recognition of capital losses that may not be currently deductible.