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Cryptocurrency: Common Requirements for Personal Taxes and Recordkeeping

The IRS identifies virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” A taxpayer’s tax situation can be complicated, if he or she owns virtual currency. Therefore, it is important to keep accurate tax records if a tax payer purchases, owns, or exchanges virtual, digital or crypto-currencies.

Cryptocurrency is one type of the virtual currency. For federal tax purposes, IRS treats virtual currency as property, instead of currency. That being said, when a taxpayer uses virtual currency to buy goods or services, or exchanges the virtual currency into a legal currency such as dollars or yen, a gain or loss may occur from the transactions.

A taxpayer needs to determine the basis of the virtual currency to calculate the gain or loss on the transactions. If he or she purchased the virtual currency, the basis would be the amount paid for the currency. If the currency was received by a taxpayer as payments for goods or services, the basis would be the fair market value of the currency on the date of receipt. The fair market value of the currency can be determined by converting the currency into U.S. dollars at the exchange rate, which is established by the market. The same rule may also apply, if the currency is an inheritance or gift.

A taxpayer has gain or loss when his or her basis is different from the fair market value of the currency when it is spent or exchanged. If the fair market value exceeds the adjusted basis, the taxpayer has taxable gain. If it is less, the taxpayer has loss. The type of gain or loss is based on why the taxpayer acquired the currency and how long the taxpayer held it. If a taxpayer has the currency as a capital asset, he or she generally recognizes capital gain or loss on the transactions. If it is not a capital asset, ordinary gain or loss is realized on the transactions.