How digital assets could impact your tax liability
April 5, 2023
The act of purchasing or exchanging assets is common for individuals and businesses alike. But what happens when you or your business buys or sells cryptocurrency (crypto), or digital assets, such as bitcoin or ethereum?
Currently, the IRS views digital assets as property per IRS Notice 2014-21. Yet the mechanisms associated with the acquisition and sale of digital assets do not always line up with those associated with physical assets.
If digital assets show up on your balance sheet, it’s important to understand how the actions you take with them could impact your tax liability. To help you determine the best course of action, here are four common activities related to digital assets and the tax implications of each.
Selling or purchasing
Given that the IRS views digital assets as property, the purchase or sale of such implies capital gains tax implications. (The price of the asset at the moment of acquisition creates basis; a change in the price upon its sale determines a gain or loss on the asset.) The IRS is most concerned with the change in price, or value, of the assets acquired—this is what triggers tax implications. So, when selling or purchasing digital assets, you can treat them as property for tax purposes.
Receiving an airdrop
An airdrop is when a company makes an unsolicited distribution (typically for free) of a digital asset to users’ wallet address. When this happens, the IRS considers it ordinary income at the moment of receipt. So, if you received the asset on December 31, the fair market value of the token or coin on this date is the taxable income you received.
If the asset fluctuates in value, now you have a capital gains tax and the ordinary income value is now your basis. If you sell the asset at a different value, you now have a capital gains implication.
Staking is the digital asset’s equivalent of earning interest. It involves contributing and locking in your assets to a network—in other words, claiming a stake to a portion of the network. By supporting the network, you receive a return (i.e., income), which is taxable.
Mining involves solving complex mathematical problems to validate and add new blocks to a blockchain. In other words, a computer digs deeper and deeper into data until it finds a mathematical sequence that is so unique, it statistically cannot appear elsewhere. This creates a block that the network can build upon.
If you were to mine a bitcoin worth $20,000, this amount would be taxed as ordinary income. As its value fluctuates, you would also incur capital gains.
How can Abdo help?
The tax implications associated with digital assets can be overwhelming, especially if you’re new to dealing in it. To help you best manage your digital assets, we can look at the ones you own, the purchases and sales you made, and to see if there were any unique occurrences or nuances in these activities. We can also guide you in properly reporting any taxable income on your tax returns.
Properly disclosing and reporting your digital asset-related activities is critical to maximizing the benefits of dealing in the digital world. To bring clarity to your strategy, contact us today.