IRS guidance for cryptocurrencies simplified

crypto taxes make you frustrated?

The Internal Revenue Service (IRS) is the U.S. government agency responsible for the collection of taxes. They had released a guidance in 2014 regarding crypto taxation, but needless to say the crypto world has grown a lot more complex since then. The IRS have recently published a much awaited and much needed new guidance for calculating crypto taxes.

We have explained the new recommendations below in layman’s terms that common folk like you and me can understand.

i. Crypto taxes on airdrops & hardforks

 

The first key issue discussed is the tax liabilities created by forking & airdrops.

  • The IRS says that if you receive new cryptocurrencies created from a fork of an existing blockchain or via an airdrop, tax liabilities will apply to your new cryptos. It has to be treated as an income “equal to the fair market value of the new cryptocurrency when it is received.”  
  • However, if you don’t have “dominion and control” over the new cryptos and cannot use them then you do not have a tax liability. For example, if you don’t receive the new cryptos because your exchange or platform doesn’t support the new forked coin, then you do not have an income.

ii. What information to maintain for bookkeeping

 
The IRS also recommends that you, as part of your bookkeeping process, must keep transaction information of all your crypto activity that must show:

  1. The date and time each unit was acquired
  2. The cost basis / fair market value* of each unit
  3. The date and time each unit was sold, exchanged, or otherwise disposed of
  4. The fair market value* of each unit when disposed of and the money received for each unit

[*see point iii. below on which fair market value to record]

iii. Determining the fair value & cost basis 

The other key issue addressed is how to determine the cost basis for each unit of cryptocurrency. Cost basis basically refers to the original value, or purchase price, of an asset.

  • The cost basis of cryptos purchased from an exchange, or received in a transaction facilitated by an exchange, is the price that is recorded by the exchange (in U.S. dollars). Hence, you must track & record the price on the exact date and time and on the exact exchange the transaction took place. This price should include commissions, fees and other costs of the purchase. 
  • For the cost basis of cryptocurrencies received through a transaction not facilitated by an exchange, the IRS says that you can use “a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time” to determine this fair market value for cost basis.
To calculate how much tax you owe, you need to calculate your capital gains on your cryptocurrency transactions. A capital gain occurs when you sell a cryptoasset for more than you spent to buy a cryptoasset. Hence, you need the purchase price (cost basis) and selling price (fair market value) for each crypto unit sold. 
 
[Our tool Cryptio automatically tracks and records all the above information for every transactions BTW ;)]
 
iv. Determining the fair market selling price 
 
The IRS also issued some guidance on what selling price to use:
 
  • While selling, you can either specifically identify the crypto unit you are selling to determine its purchase price (cost basis) and selling price. You can do this using “the specific unit’s unique digital identifier such as a private key, public key, and address,” or identify the crypto lot sold “by records showing the transaction information for all units”
  • Alternatively, instead of individually identifying each crypto unit, you can use the ‘first in, first out’ (FIFO) accounting method. We have explained FIFO here in this guide. In short it assumes the first crypto sold is the oldest crypto that you purchased.
The general consensus about this new guidance is that though it answers some questions, it also raises new confusion. But it has made one thing very certain – Businesses and individuals dealing in cryptocurrencies must meticulously document all their crypto transactional activity to be prepared for the tax season.
 
If you need any accounting or bookkeeping assistance with regards to how you can set up a system that records & documents your crypto activity, please don’t hesitate to get in touch below!
 
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