Cryptocurrency’s value plummets. Here’s what it means for your taxes

Holders of cryptocurrency have more than price volatility to worry about this year. The taxman wants to know about your trading activity.

Bitcoin hit fresh highs during the weekend, creeping toward $42,000 on Jan. 8. However, its value tanked on Monday amid a sell-off in cryptocurrencies, and bitcoin’s value is now hovering around $33,000.

Regardless of whether you interpret the decline in price as a buying opportunity or an alarm to get out, you’ll need to share the information with the IRS.

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Transactions you partake in this year will be reportable when you submit your 2021 tax returns next spring.

This tax season, the taxman asks a “yes or no” question on the front page of the 2020 federal income tax return: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

“If you’re particularly active using bitcoin, not only is every transaction potentially income or a deduction, but when you use it to pay for goods, you could have reportable gain on that bitcoin,” said E. Martin Davidoff, partner-in-charge in the national tax controversy practice of Prager Metis.

Buying and selling cryptocurrency aren’t the only actions that create a reporting obligation.

You’d also have to check the “yes” box on your tax return if you happened to pocket any crypto for free or if you received your holdings in exchange for goods or services.

Swapping your bitcoin for other property is also a reportable transaction.

That’s where things can get messy, since users may be using multiple exchanges or platforms for their crypto trading activity.

Some exchanges will only provide you with a Form 1099-K for tax time. It contains the details of your activity if you’ve had gross payments exceeding $20,000 or you’ve made more than 200 transactions.

That means the onus for accurate recordkeeping, reporting and tax payment is really on the investor.

“You have to keep track of every transaction you did, every sale,” Davidoff said.

In general, the IRS regards virtual currency as property. That means if you sell your holding, you’ve either racked up a capital gain or a loss.

Meanwhile, wages that are paid to you in cryptocurrency will be reported to you on a Form W-2, which your employer must send you by the end of this month. Federal income tax and FICA taxes would apply to the payment — as they do for wages paid in dollars.

Cryptocurrency that you mine must also be included in your taxable income. In this case, you would include the fair market value as of the day you received it.

Failure to report the income can lead to penalties and interest — and in the most extreme cases, prison and fines up to $250,000.

Indeed, back in 2019, the IRS sent letters to thousands of taxpayers with virtual currency transactions, notifying them to pay back taxes and submit amended returns.

Aside from tracking your transactions, tax professionals recommend keeping detailed records of your basis or your original investment in the asset.

How long you’ve held the asset before you transact with it also matters.

If the holding period exceeds one year, you’re subject to favorable long-term capital gains treatment when you sell your virtual currency. In that case, the tax on appreciation can be 0%, 15% or 20%.

However, if you sell your virtual currency less than a year after acquiring it, ordinary income tax rates kick in. Those rates can be as high as 37%.

You do have to track your basis even if you use your bitcoin to buy things at a merchant, so be mindful of how you transact.

“If you’re having to choose between using your U.S. currency versus crypto, at least with cash you don’t have to track the basis,” Davidoff said. “It’s a huge headache.”