Virtual Currencies, NFTs, and Income Taxes

Virtual
Currencies

Just as any other currency, a virtual currency or cryptocurrency might be used to pay for goods or services or as an investment. These are often digital coins, but other types, such as non-fungible tokens (NFTs), have also gained popularity. With their rise, many wonder how income from these sources is taxed. Understanding the tax implications of virtual currencies and NFTs is crucial for anyone dealing with them, as different rules can apply depending on how these assets are used or sold. This guide will help clarify the tax treatment of these digital assets.

How should I report transactions involving virtual currencies on my tax return?

The IRS requires a check in the Yes or No box for a question regarding certain investments, including digital currencies. If you made any transactions involving a virtual or crypto currency, you would need to select Yes.

A transaction involving virtual currencies can be:

• Sending or receiving virtual currency in exchange for goods or services
• Receiving or transferring virtual currency for free which does not qualify as a bona fide gift
• Acquiring a new virtual currency after mining, staking, or as a result of a hard fork
• Exchanging or trading virtual currency for another virtual currency
• The sale of a virtual currency
• The disposition of any financial interest in virtual currency.

If you partook in any of these, you should select Yes on eFile.com when you are asked if you made any exchanges of virtual currency. This is because the Form 1040 specifically asks if the taxpayer sold or exchanged virtual currency during the year. You can report your virtual currency exchanges or sales under the investments tab and they will be generated on Form 8949 and Schedule D - eFileIT.

New: the IRS is currently developing Form 1099-DA for digital asset exchanges. The linked page will have instructions once the IRS provides the form and guidance.

Virtual currency you received in exchange for service or goods should be reported as the income type it was received for - for example, if you were paid in a digital coin for freelance or gig work, then you would report this as freelance or self-employment work under the Business section. eFile will report this on your Form 1040 and Schedule C or Schedule 1 as applicable - eFileIT.

KEY TAKEAWAYS

• Taxpayers must report all forms of virtual currency transactions, including trades, sales, and payments, regardless of whether they were profitable.
• The IRS considers virtual currency as property, not currency, which impacts how gains and losses are calculated and reported.
• Deadlines for reporting virtual currency transactions are the same as for other tax filings. Ensure all transactions are included in your tax return by the deadline.
• The IRS Form 1040 asks if you received or disposed of digital assets during the year. Ensure you answer this question accurately to avoid potential issues.
• NFTs are taxed like collectibles with a potential 28% tax rate on gains. If sold within a year, short-term capital gains tax rates apply; otherwise, long-term rates are used.

Generally, virtual currencies are a digital representation of value that functions as a medium of exchange. Virtual currencies have an equivalent value of another real currency, such as the U.S. Dollar, Euro, etc. They might be accepted as a medium of exchange or payment, but, as of now, they do not have a legal tender status in any jurisdiction.

Digital, Virtual, or Crypto Currency

Virtual currencies are all part of a hierarchy of terms, but most commonly refer to them as cryptocurrencies. They are a type of virtual currency which is a subset of digital currency. Virtual currencies are not regulated by a central bank which is why its value tends to fluctuate so drastically. They are bought and sold in a blockchain network to ensure security.

The IRS and this page also refers to the general umbrella of virtual, crypto, or NFTs as digital assets. These include:

• Convertible virtual currencies or cryptocurrencies like Bitcoin
• Stablecoins
• Non fungible tokens (NFTs).

Convertible virtual currency, such as cryptocurrency, is a digital asset that holds value equivalent to real currency or serves as its substitute. It can be utilized for purchasing goods and services, traded electronically, and exchanged or converted into other digital assets or traditional currencies. In most cases, investors use these to make passive income.

How to Add Crypto or Virtual Currency Income to Tax Return

These sales are treated the same as when you trade a stock or sell any other asset. You should receive a 1099-B for your sale which can be added to your return. When you file your taxes using your eFile account, you will add this income under the Investments tab and eFile will generate the required forms, including Schedule D, and eFileIT.

Not sure when to report virtual currency transactions on your 1040 tax return? The latest IRS Form 1040 asks this question, updated to include specifications to alleviate confusion:

At any time during [tax year], did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)? - IRS, Form 1040, Digital Assets section.

This is simply asking if you sold or received a digital asset, such as a virtual currency. Everyone must answer this question; to be sure you do not miss it, file your taxes online through your eFile account and you will be asked this question. eFile does not allow you to e-file without answering the question so you can be sure it is not missed.

You should check "yes" to the question on Form 1040 if:

• You received a digital asset or assets as payment for property, service, or as an award.
• You received a digital asset from mining, staking, similar activities, or from a hard fork.
• You disposed of a digital asset to exchange or trade for another digital asset; sold it for currency, or disposed of another financial interest in a digital asset.

How you answer it depends on your involvement with exchanging virtual currencies or digital assets. Refer to this table below on common situations to help determine how to answer this question.

You can report virtual currency transactions for your tax return on eFile.com; start for free and see how to add virtual currency exchanges to your return. The IRS requires a check in the Yes or No box for the question regarding certain investments, including digital currencies. If you made any transactions involving a virtual or crypto currency, you would need to select Yes.

Virtual currencies are traded and exchanged digitally between buyers and sellers of the currency. Read more here about what to consider when selling virtual currencies and other assets. See more detailed information on regulations to persons administering, exchanging, or using virtual currencies.

Most taxpayers invest in crypto as if they are stocks, often in order to invest or generate passive, unearned income. With the exponential increase in value over the years, virtual coins like Bitcoin have seen more than a 10,000% increase in value. Virtual currencies often have tax consequences that may result in a tax liability when traded. Like stocks or other investments, these transactions are often assessed tax only when traded. If you sold crypto at a capital gain or loss, you would want to report it on your income tax return. There may be tax deductions if you lose money on this while a gain would be taxed as income. eFile.com will handle this all for you and help report any of your virtual currency information on your tax return.

Virtual or Crypto Currency and Taxes

A virtual currency is treated as property or asset, thus it is treated as a property transaction when it is disposed or sold. As a result, it is not treated as a currency that could generate foreign currency gain or loss. See information on FinCEN FBAR Report 114.

If you make a profit from crypto or virtual currencies and held that asset for less than one year, then the income is taxable at your usual tax rate. If you held it for longer than a year, then it is taxed at the long-term capital gains rate which is generally less. You should expect to pay taxes when you file your return if you made gains of any amount from selling your virtual currency. Like any other asset, you do not pay taxes on anything you don't sell. If you swap or exchange one crypto for another - you

When selling crypto or virtual currencies and losing money, you can generally deduct these losses like you would when selling a stock you lost money in - eFile will help you reconcile your gains and losses. You can minimize or offset your gains or pay less taxes on crypto by holding onto the currency for at least one year, selling some assets at a loss (see tax loss harvesting), or consider donating your crypto to charity.

If a virtual currency is used to pay for goods or services, it is treated as U.S. dollar fair market value for tax purposes. See Publication 525, Taxable and Nontaxable Income and exchanges involving property or services and Publication 551, Basis of Assets for computing of the cost basis value. The fair market value of a virtual currency in U.S. dollars is based on the date of payment or receipt.

If a virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has to report a taxable gain. This is also the case if there is a gain or loss in exchange of virtual currency for other property, like real estate. See more information about the sales and other dispositions of assets.

If a taxpayer mines a virtual currency, the virtual currency fair market value is set as of the date of receipt of gross income. See more information about taxable and nontaxable income, including examples. If you make charitable donations with virtual currency, then the donation is treated as a non-cash contribution equal to the fair market value of the currency at the time of donation.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. This can be anything like a payment for performing work or services and receiving virtual currency as payment. For example, if a person makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services, they required to report that payment to both the payee or recipient and the IRS via Form 1099-MISC. You can include this form when you prepare your return on eFile.com.

Payments of virtual currency need to be reported using in U.S. dollar based on the fair market value of the virtual currency as of the date of payment as outlined above.

When you prepare your return on eFile.com, you will be asked if you bought, sold, or received any form of virtual currency during the tax year. Be sure to answer this question accurately and honestly and the eFile Tax App will help you report this and other investments you may have on your tax return. Tax Tip: if your only virtual currency transactions were purchases that were made with real currency in U.S. Dollars (USD), you do not have to answer yes to this question.

NFT - What Is It?

Guide for
NFTs and Taxes

NFT is an abbreviation for non-fungible token. An NFT is a digital certification that grants one the ownership rights of a blockchain - most commonly, Ethereum (ETH) - which has its own unique value. In other words, an NFT is a digital piece of property one can buy and own which cannot be duplicated.

Examples of NFTs include the popular selling of the first Tweet ever made which was purchased for $2.9 million, a digital piece of original art or history, digital trading cards, or an online essay. The purchaser receives the digital product as well as all the rights to the property. A simple way of understanding it is this: anyone can look up a picture of the Mona Lisa and print it out, but it will not be authentic. An NFT is a digital original that can not be copied.

NFTs and Taxes

The IRS guidance on the taxation of NFT sales or exchanges states that they are treated as collectibles digital assets like virtual currencies. When it comes to income taxes, you may pay taxes on gains or profit from the sale of your asset. This is similar to collectibles like buying baseball cards, pieces of art, antique cars, or other items that hold or increase value over the year. When the sale occurs years later, you may sell the item for more than you paid for it, resulting in a capital gain.

Since NFTs are often purchased with cryptos, they are taxed similarly. This is because they can be used in exchanging cryptocurrency. Most exchanges of NFTs include selling the NFT for a cryptocurrency, buying an NFT with a cryptocurrency, and trading an NFT for a different NFT. Consider the following when creating, buying, selling, or trading a non-fungible token:

Creating, Selling an NFT

If you create and sell your own NFT - for example, as an artist, you draw your own original avatar and sell it online on sites like OpenSea - then the income from this exchange would need to be reported on your income tax return. You will owe tax at your ordinary income tax rate, but will also owe self-employment taxes as creating and selling your work is considered self-employment work. This is not a capital gain as you did not invest in the NFT, you instead created and sold a piece of property.

Investing, Trading NFTs

The process of purchasing an NFT can be boiled down to purchasing a supported cryptocurrency (often, Ethereum or ETH) with your money in order to build a digital wallet. Then, purchase the NFT using the currency. You then own the NFT; this is similar to buying a stock and the tax treatment of the NFT is like owning a stock.

The tax implications in this instance are dependent on the gain or loss on the crypto as well as how long the NFT was held. If the crypto you used to purchase the NFT is appreciated or has gone up in value since you purchased it, you would owe capital gains tax. If you held the crypto for over a year, you would owe long term capital gains (for less than a year, you would owe short term gains tax). If, however, your crypto was depreciated or you lost value, then you would report a loss which may lower your tax liability.

In selling an NFT, there are two ways to do this: sell an NFT for a different NFT or sell for cryptocurrency. When you trade one NFT for another, this transaction is treated as a capital gain or loss as well. This is determined by whether or not the NFT you sold was less valuable than the one you purchased. In other words, if you acquired an NFT valued at $5,000 by selling an NFT you owned at $4,000, then you would be responsible for a gain of $1,000 and be taxed on this. When you sell an NFT for crypto, you will incur a gain or loss. If you sell an NFT worth $2,000 ETH and sell it three years later for $6,000, then you have a capital gain of $4,000.

How an NFT Is Taxed

NFTs are taxed as digital assets similarly to cryptos and capital gains and losses may be assessed since they are property. Long term gains rates are anywhere from 0-20% of the sale of the asset or property. If the sale or trade took place within a year for a profit, this is treated as a short-term gain and would be taxed at your ordinary tax rate for income.

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