Cryptocurrency Tax Liability Demystified

Concept of cryptocurrency head

Cryptocurrencies mooned while COVID-19 shook the world. Global economies halted, fear and panic spread, and many businesses closed. 2020 was a roller coaster ride many would like to forget, while others solidified their status as cryptocurrency millionaires. Back in 2010, Laszlo Hanyecz, a programmer, traded 10,000 bitcoins for two Papa John’s pizzas. Bitcoin broke $60,000 per coin in 2021 after a steady rise throughout the COVID-19 pandemic. 

Cryptocurrencies have been a hot topic long before COVID-19. With websites like Reddit and DD Squad, a community for asset due diligence, buzzing about cryptocurrencies, there is no wonder why coins like bitcoin, Litecoin, and Ethereum have gained traction over the last few years. Their increasing desirability by investors has been watched by retailers, who have expanded their payment options to include cryptocurrencies. Tesla recently began accepting bitcoin for its vehicles. Retailers such as Microsoft, AT&T, and Overstock.com accept bitcoin too. Travel companies like CheapAir and Norwegian Air let you pay for air travel with bitcoin while Virgin Galactic, part of Richard Branson’s Virgin Group of companies, lets you use bitcoin to pay for space travel. You can even go so far as purchasing a lavish home complete with top-tier amenities using bitcoin – it is insane. These retailers and many others have opened their eyes and payment gateways to a future that appears to be pro-cryptocurrency.

As of now, it seems safe to say that cryptocurrencies are not going anywhere. More and more practical applications are being developed to offer cryptocurrency owners ways to easily spend their coins. This includes finding a bitcoin ATM and withdrawing cash as you would any other ATM. Little known, however, are the financial implications of using cryptocurrencies, such as bitcoin, to make purchases. There are a few rules to be aware of before deciding to click ‘pay with bitcoin’ or another cryptocurrency.

The Internal Revenue Service (IRS) has defined cryptocurrencies, known as ‘virtual currencies,’ as assets with stored value. According to the IRS, “virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Moreover, the IRS further holds that the “sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.” Generally, “virtual currency is treated as property” for federal tax purposes. In this respect, sales of and purchases using virtual currencies are like stocks and other investments. “General tax principles applicable to property transactions apply to transactions using virtual currency.” This means that withdrawing the cash equivalent or making purchases using cryptocurrency can leave you liable for any value gained since first mining or purchasing the cryptocurrency used. Failure to pay taxes on such gain will likely create a tax liability for which you will be on the hook. 

Although they are called cryptocurrencies, coins like bitcoin, Litecoin, and Ethereum are not treated as foreign currencies for tax purposes. It is important to understand the financial consequences of owning, selling, and using virtual currencies to make purchases. Every financial situation is unique. You should speak with a qualified financial professional before investing entering or exiting any cryptocurrency position. 

View this article in the July 2021 issue of MP.