Many investors in Bitcoin and other virtual currencies have been confused about how those investments are taxed. As we’ve noted before on this blog, cryptocurrency gains are taxed like capital gains. That means that you’ll need to keep detailed records on what you paid and what you got when you sold the virtual currency. You will be taxed based on the difference.
Additionally, if you transfer virtual currency between two accounts (“wallets”), you must also document those transfers in order to show the IRS that the transfer was tax-free.
And, if you hold a virtual or cryptocurrency investment for less than a year, your gains are taxed at the short-term capital gains rate. You need to hold them for a year before they qualify for the preferential rate of 23.8%.
Recently, the IRS issued a ruling and a Q&A document on reporting gains from virtual or cryptocurrency investments. That’s important because auditors are currently focusing on these investments, according to Accounting Today. The two documents provide useful guidance for those with virtual currency investments and those who receive virtual currency in other transactions, such as payment for services.
A ‘hard fork’ is a taxable event
For virtual and cryptocurrency investors, one issue to keep an eye out for is when the currency splits in what is called a “hard fork,” where the split e-coins are distributed via air drop. According to the IRS, this is a taxable event and you must pay the appropriate capital gains taxes.
“One unfortunate consequence of this guidance is that third parties can now create tax reporting obligations for you by simply forking a network whose coins you own, or foisting on you an unwanted air drop,” said the advocacy group Coin Center in a statement.
If you are concerned about how to account for virtual currency investment income or how virtual currency is taxed otherwise, discuss your situation with an experienced tax attorney.