When we are filing the 1040 of any individual, the most common question for any person is about virtual currency. Here I have tried to explain virtual currency in simple terms.
Definition of virtual currency – Any currency which is not a real currency (US$ or other foreign currency) and mostly includes cryptocurrency. Examples of cryptocurrencies are Bitcoin, Lite coin, Monero, and Dogecoin.
1. Question asked in 1040 for virtual currency – Whether at any time during 2021/2022, I received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency? What should the answer to the question be explained below? But it is necessary to understand the purpose of the question asked in 1040.
2. Purpose of the question – Virtual currency is also a property like any other property. It is your asset that can be purchased, sold, exchanged, etc. so the IRS wants to know the gain/loss on the sale of virtual currency.
3. Answer is No – In the following scenarios, your answer is no:
A. When you don’t have any transactions relating to virtual currency.
B. When you purchase the virtual currency and hold it.
When you sold any virtual currency during the year, it is required to report in 1040. When you sell the virtual currency then capital gain/(loss) needs to report in 1040.
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Certain cases need to be considered while preparing 1040 or the books of accounts:
1. Treatment of virtual currency received on sale of goods/service – Treat as a business income and considered the adjusted basis of virtual currency with Fair Market Value(FMV) in US$ as on the date of receipt.
2. Treatment of virtual currency received as remuneration from employer – Treat as salary income and considered the adjusted basis of virtual currency with Fair Market Value(FMV) in US$ as on the date of receipt.
3. Treatment of payment of expenses in virtual currency – Treat as an expenditure and exchange of asset(virtual currency) and calculate capital gain on the exchange of virtual currency.
4. Treatment of exchange virtual currency for other property – Consider the exchange of the property and gain/loss on the same transaction as the difference between the fair market value of the property you received and your adjusted basis in the virtual currency exchanged.
5. Treatment of exchange of other property for virtual currency – Consider the exchange of the property and gain/loss on the same transaction as the difference between the fair market value of the virtual currency when received (in general, when the transaction is recorded on the distributed ledger) and your adjusted basis in the property exchanged.
6. How to determine taxability in Hard Fork? – When you receive any new cryptocurrency due to Hard Fork, then it is taxable based on the adjusted basis determined from FMV as on the receipt date.
7. How to determine taxability in Soft Fork? – Not taxable as any new cryptocurrency is not received in Soft Fork.
8. When virtual currency is received as a gift? – Treat it as a normal gift and recognize gain/loss on sale accordingly.
9. Donation of digital currency to charity – Allowed as a deduction amounting to FMV of it at the time of donation.
10. Transfer of virtual currency from one wallet to another – Not taxable.
11. How to identify adjusted basis out of multiple units of virtual currency when sold – Either separately identify each unit or FIFO method.
What records to maintain regarding virtual currency? – IRS requires maintaining records that are sufficient to establish the positions taken on tax returns. For example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.
