How To Answer IRS Digital Asset Tax Question
The Internal Revenue Service (IRS) continues to refine and update queries regarding cryptocurrencies and digital assets. The 2022 draft for 1040, released on September 1st, shows the latest version of the cryptocurrency question, which states:
At anytime during 2022, did you:
(a)- get cryptocurrency as an award, reward, or compensation
(b)- exchange, sell, or dispose of a digital asset?
In 2022, the IRS will likely take a more direct approach than before by further defining the terms. The goal of the question is clear. The IRS wants to see who has digital asset and cryptocurrency transactions that are reportable for tax purposes. However, there is still a need to be guided by digital asset CPA that understands cryptocurrency tax and cryptocurrency accounting. Let’s first see how cryptocurrency taxes and digital asset taxes work.
The IRS Classifies Digital Assets and Virtual Currencies as Property
The IRS classifies cryptocurrency and other digital assets such as NFTs as property instead of a currency. It means a transaction involving digital currency, such as exchange or sale, results in capital loss or gain for tax reporting purposes. According to the IRS, if a property’s fair market value (FMV) received in exchange for digital currency exceeds the taxpayer’s adjusted basis, then they have to report taxable gains.
For every transaction, the taxpayer needs to compare the virtual currency’s cost basis against the fair market value of the services or goods they are getting in exchange. If the FMV against the cost basis exceeds, it will be considered as income. However, taxpayers can claim a loss if the cost basis exceeds the FMV of the digital asset.
The IRS has revised the digital asset question on the 1040. They revised question realted to digital assets that are received to include “gifts”. The other significant change to the question was substituting “virtual currency” with “digital asset.” This change has included NFTs into the scope of the question.
When you can check ‘No’ To The Digital Asset Question On Form 1040
Taxpayers merely owning digital assets or virtual currencies at any time in 2022 can check the box ‘No’ when they didn’t engage in any transactions involving digital assets during the whole year or their activities were restricted to:
Transferring a digital asset or virtual currency between their wallets or accounts.
Holding a digital asset or virtual currency in their wallet or account
Purchasing a digital asset or virtual currency through fiat currency
Engaging in a combination of transferring, holding, or purchasing digital currency in manners mentioned above.
When You Must Answer ‘Yes’ To The Digital Asset Question On Form 1040
Here are some of the most common transactions in digital assets and virtual currencies that must answer ‘Yes’ To The Digital Asset Question On Form 1040:
The receipt of a digital asset or virtual currency as the payment for services or goods provided
The transfer of a digital asset or virtual currency for free, that does not qualify as a bona fide gift
The receipt of a digital asset or virtual currency as a hard fork’s result
The receipt of new a digital asset or virtual currency as a result of staking and mining activities
Digital asset or virtual currency exchanged for goods, services, or property
A trade of a digital asset or virtual currency for another virtual currency
A disposition of a financial interest in a digital asset or virtual currency
A sale of a digital asset or virtual currency
If a taxpayer disposes of a digital asset or virtual currency held as a capital asset via a transfer, exchange, or sale, they must check ‘Yes’ to the digital asset question on Form 1040 and use form 8949 to figure out their capital loss or gain and report the digital asset and/or virtual currency on Schedule D, Form 1040. Even with existing IRS guidance, there are still unclear reporting requirements. For example, it’s still unclear whether a taxpayer who owns cryptocurrency or digital asset through a pass-through entity needs to check “Yes” for the question for tax reporting purposes. The “financial interest” portion of the question is still subject to interpretation.
As we all know, transactions involving virtual currency and digital assets has continued to expand as an investment and payment method. Taxpayers should carefully proceed to experience the benefits of digital currency while avoiding its drawbacks. They should familiarize themselves with the complexities of digital asset accounting and digital asset tax reporting rules and understand their obligations when undertaking digital asset transactions.
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