|Virtual currency is treated as property for Federal tax purposes by the IRS and is taxed accordingly. As a result, you must recognize gain or loss on the exchange of virtual currency for cash or other property. This is for all transactions in which virtual currency is sold, traded for a different virtual currency, or as payment for goods or services (received or provided). It also applies to “mining” cryptocurrency as well as for new units received through a hard fork if at the time of receipt you have the ability to dispose of the new units.
The IRS website has an FAQ page with excellent information. https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
A CPA Journal post from January 2019 provides an informative explanation of the taxation of cryptocurrency in the most common circumstances. https://www.cpajournal.com/2019/01/24/the-taxation-of-cryptocurrency/
When Do You Owe Taxes On Your Crypto?
Whenever you incur a taxable event from your crypto investing activity, you incur a tax reporting requirement.
A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:
- Trading crypto to fiat currency like the US dollar
- Trading one crypto for another cryptocurrency
- Spending crypto to purchase goods or services
- Earning crypto as income
Below, we run through practical examples to illustrate each of these taxable events.
- Crypto ➔ Fiat (USD)
Emma buys 2 ETH from Coinbase for $1,200. A few months later, Emma sells her 2 ETH for $1,000.
Selling crypto for fiat currency is a taxable event. In this example, Emma incurs a $200 capital loss (1,000 – 1,200). This loss gets deducted and actually reduces Emma’s taxable income.
- Crypto ➔ Crypto
John purchases 5 Litecoin for $250. After holding onto his Litecoin for a couple of months, John trades all 5 Litecoin for 0.5 ETH. At the time of the trade, 5 Litecoin is worth $400.
In this scenario, John incurs a taxable event by trading his Litecoin for Ethereum. Trading one crypto for another is treated as a disposal, and here John incurs a $150 capital gain from the trade which he would need to report on his taxes (400 – 250).
- Crypto ➔ Goods/Services
Taylor owns 5 bitcoin, each of which she bought for $100 pre-2014. Taking advantage of her new found wealth, Taylor uses 3 bitcoin to purchase a new Tesla for $51,000. At the time of buying the car, 1 bitcoin is worth $17,000.
In this example, Taylor incurs a taxable event when she disposes of her bitcoin for the new Tesla. She incurs a $50,700 capital gain in doing so (51,000 – 300) and needs to report this capital gain on her taxes.