Back in 2014, the IRS issued Notice 2014-21 which described how existing general tax principles apply to transactions using virtual currency. This notice contained 16 Q&As, which have now been amended and added to the 2019 ruling, resulting in a whopping 43 questions and answers that cover the entirety of crypto taxation issues.
Fair Market Value:
Fair Market Value (FMV) is typically defined as the selling price for an item to which a buyer and seller can agree. For crypto, FMV is the value of the currency when you received it, and the adjusted basis in the property exchanged.
According to the ruling, a virtual currency’s value is determined by the cryptocurrency exchange and recorded in U.S. dollars. However, when it comes to Peer-to-Peer (P2P) transactions or other transactions not facilitated by an exchange, the FMV is determined according to the date and time at which the transaction is recorded on the distributed ledger and on-chain transactions.
Cost basis is the original value of an asset for tax purposes. For virtual currencies, cost basis is the amount you spent to acquire the virtual currency, including fees, brokerage commissions from exchanges and other acquisition costs in U.S. dollars.
Your adjusted basis is then your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars.
To calculate the accurate cost basis, you must determine first which units of currency were sold, exchanged, or disposed of and match the purchasing cost for these units.
The practice of cost basis can be tedious to navigate, which is why Bittax’s proprietary algorithm takes the guesswork and aggravation out of the equation for you – it even advises users to which currency should be sold or kept in order to make the most fiscally responsible decisions.
Pay careful attention to this issue, because for the first time ever, the IRS has clarified that the preferable method of calculation for crypto is Specific Identification (SI) – and doing this right could save you money. If you cannot or are unable to use it, the First-In, First-Out (FIFO) method should be used.
SI is used to track individual units of virtual currency, and is applicable only when units can be clearly identified to provide a complete report on movements of crypto assets including addresses, wallets, exchanges, etc. It identifies the Unspent Transaction Output (UTXO) of your virtual currency in real-time, and calculates your tax liability on the sale of that currency – providing clear-cut, accurate results.
Taxpayers can identify specific units by unique digital identifiers such as private and public keys and addresses, or with records showing the transaction information for all units of a specific virtual currency (such as Bitcoin) held in a particular account, wallet, or address. SI must exhibit the date and time each unit was acquired, the cost basis and FMV of each unit at the time of the acquisition, as well as the date, time, FMV, and sale value or price of each unit when it was sold, exchanged, or disposed of.
FIFO, however, does not take real-time user activity into consideration, and is much more labor-intensive and tedious. When using FIFO, taxpayers must list all purchases and sales, and then match them. To match, take the first item on the purchase list and calculate the tax results as if the unit was sold on the date and at the price of the first sale in the sales list. FIFO can result in over-taxation, especially, for example, if you bought your first Bitcoins in the early years.
To accurately use the SI method in 4 simple steps, use the Bittax platform. Its innovative algorithm is perfect for implementing SI for virtual currency reporting, allowing you pre-plan your taxes per your online trading transactions.
Reporting and Documentation
When compiling a report and filling out the appropriate documentation, taxpayers must report all income, gains, and losses incurred by all taxable transactions, regardless of the amount. IRS codes and requirements are stringent, so taxpayers are advised to maintain thorough documentation on receipts, sales, and exchanges in order to establish validity on their tax returns.
To report a gain or loss, complete Form 8949, Sales and Other Dispositions of Capital Assets, and then summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses.
Report ordinary income on Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income (PDF), as applicable. Ordinary income is considered income from wages, salaries, tips, commissions, bonuses, interest, dividends, or net income from a sole proprietorship, partnership or LLC.
For clarification and expert guidance on the above issues, contact Bittax’s highly-qualified crypto tax professionals today. Leaders in the industry, their wealth of knowledge and innovative tools will help you knock out that crypto tax report in no time.
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