If you are a cryptocurrency fan, heads up! Next tax season, the IRS will ask you whether you have invested in or used cryptocurrencies. What are the ramifications of having these investments and what changes has the IRS made since 2019? Will you owe more tax?
The IRS began asking about cryptocurrencies in 2019; however, it was only included on Schedule 1 of the 1040 tax form. Schedule 1 is an additional form used to disclose other income or adjustments to income. Schedule 1 is not a widely used form for many tax filers, so cryptocurrency investors could “accidentally” overlook it.
For 2020, the IRS is moving the question to the front page of 1040, right above where you list your income and your dependents. This means every taxpayer will have to answer this question, and the ability to "overlook" it will be gone.
The question: "At any time during 2020, did you sell, receive, send, exchange or otherwise acquire any financial interest in any virtual currency?". You will only have two choices: Yes or No.
Why is the IRS Making this Change?
According to a Wall Street Journal article, one tax-prep software firm believes fewer than 150,000 cryptocurrency owners filed the required tax forms. According to Statista.com, in the third quarter of 2020, there were over 53 million cryptocurrency accounts worldwide. Assuming U.S. citizens hold a decent chunk of those, the number filing the appropriate tax forms seems small. Obviously, the IRS noticed this and decided to move the question to the front page. They have eliminated the ability to overlook or not understand the taxes owed with cryptocurrencies by asking a straightforward yes or no question.
Cryptocurrency Tax Nightmare?
The IRS treats cryptocurrencies as property for tax purposes. This is similar to owning a stock. If you have gains in the cryptocurrency, you will owe taxes on the gains when you sell it. Likewise, if you have losses, you can use your losses to offset the gains.
The problem for many cryptocurrency users is keeping track of cost basis, particularly if you have made many purchases over time. Also, cryptocurrency exchanges provide limited tax reporting for many investors for a variety of reasons. So investors may be in for some serious tax work come April next year, mainly if they haven't kept great records. Even if you use cryptocurrencies to buy goods, you still have to pay taxes on any gains those currencies made.
What to Do?
If you have exchanged or traded cryptocurrencies in 2020, there is nothing to worry about if you plan. If you have kept good records, and have limited trades, adding this to your tax return won't be a lot of hard work.
If your record keeping has been spotty or if you trade quite a bit, you may want to research cryptocurrency tax software to see if it is worth the investment. Or, set aside more time to work on this in advance, so you aren't scrambling come tax time. If you are working with a CPA, you might talk with them about handling your trades and seeing if there is a preferred software they recommend.
As cryptocurrency investing becomes more popular, the IRS will shine a larger spotlight on tax reporting. Understanding the issues and knowing what you need to do will make April 2021 a slightly smaller headache.
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Please remember that past performance may not be indicative of future results. Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.
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