As digital assets become increasingly common, the tax rules surrounding these assets are of critical importance. Various digital assets, such as Bitcoin and other virtual currencies, digital content, and blockchain-based securities, have different tax treatment. This article will focus on some important points regarding digital assets.
What is included in a digital asset?
Digital assets include: Typical examples are listed below, but there are many other forms.
- Convertible Cryptocurrency and Virtual Currency
Cryptocurrency refers to a digital currency that is primarily created using cryptographic techniques and emphasizes its security and safety of transactions. Typical examples include Bitcoin and Ethereum. The term is usually based on distributed ledger technology (blockchain), which operates independently of a central authority such as a central bank or government.
On the other hand, virtual currency is a broad category term that simply refers to currencies that do not have a physical form, and includes not only those based on cryptographic technology, but also in-game currencies, central This also includes bank digital currencies (CBDC). This may include some that do not technically use blockchain technology. - Stablecoins
Stablecoins are virtual currencies designed to stabilize their value with other assets, usually currencies or commodities. It is said to have a “stable” value because its value fluctuates relatively little. The main use is to reduce volatility in the virtual currency market and to be used as a base currency during trading. Representative stable coins include USDC and USDT. - Non-fungible tokens (NFTs)
Non-fungible tokens (NFTs) are tokens that are unique and not fungible. This means that each NFT has unique data and information and cannot be exchanged with other NFTs. NFTs are used to represent a variety of digital content and physical assets, such as digital art, music, virtual world assets, and gaming items. - Blockchain-based Securities
Some companies are issuing traditional financial products such as stocks and bonds on blockchain, treating them as digital assets.
How are digital asset transactions taxed?
Generally, individuals who engage in transactions in digital assets, such as buying, selling, or exchanging digital assets, hold the digital assets as capital assets and incur capital gains or losses as a result of the sale or exchange. However, digital assets received in exchange for services are treated like wages and generate regular income for the recipient who holds the digital asset as a capital asset.
Sales
When you sell digital assets, you must report the transaction along with any capital gains or losses from the sale.
<Example 1>
Nancy purchased 5 Bitcoins for $35,000 in January. If you sold all your Bitcoins in July for $40,000, your short-term capital gain would be $5,000 (sell price $40,000 minus purchase price $35,000). If Nancy sells her Bitcoin for $32,000, she will incur a short-term capital loss of $3,000 on the sale, subject to the capital loss deduction limitations. The fact that Nancy sold the coin is important for her to realize the loss. She may not report a loss merely because the coins she holds declined in value.
Exchanges
When you exchange digital assets for goods or other digital assets, you must report the difference between the fair market value of the asset or service received and the basis of the digital asset given up as a capital gain or loss.
<Example 2>
If Hisako buys 5 Bitcoins for $35,000 dollars in January, and in May exchanges all her Bitcoins for another virtual currency worth $30,000 dollars at the time of exchange, Hisako will earn $5,000 dollars ($30,000-$35,000) on that transaction. =-$5,000) to report a short-term capital loss. In this case, Hisako would need to identify other capital losses, which could limit the amount she can deduct in the current year. Similarly, if the value of the exchanged virtual currency was $50,000 dollars instead of $30,000 dollars, Hisako would report a short-term capital gain of $15,000 dollars ($50,000-$35,000=$15,000) on the transaction.
Hard Fork and Airdrop
A hard fork occurs when an existing currency or protocol (arrangements/rules) changes in blockchain technology. If this change has a significant impact, a new currency may be created. Bitcoin Cash is a typical example of a Bitcoin hard fork. A hard fork creates a new currency, so the original currency and new currency exist independently.
Airdrop is a method of distributing currency or tokens for free to holders. This is typically done for new projects to increase visibility or build a community. Airdrops distribute a certain amount of currency to users who meet certain conditions. Conditions can vary, such as owning a certain virtual currency or accessing the network during a certain period of time. By receiving an airdrop, holders can obtain new currency for free.
Receiving new tokens through a hard fork or airdrop is considered income and may be taxed.
<Example 3>
Bill held 10 units of cryptocurrency A. He also owns 10 units of cryptocurrency B, which was subsequently hard forked. Regardless of how he receives the new cryptocurrency B, he has earned income. If Bill is worth $50 on the date he receives 10 units of cryptocurrency B, he must report $50 as taxable income in the year he receives cryptocurrency B.
Earnings
If you receive property, including digital assets, in exchange for performing services, you must report the revenue as ordinary income. Compensation for services is reported and taxed the same regardless of how the compensation is received (dollars, virtual currency, real estate, or other services). If you receive digital assets in exchange for providing services as an employee, they are considered wages and are subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) taxes, and Federal Unemployment Tax Act (FUTA) taxes. As with traditional wages paid in U.S. dollars, a Form W-2, Wage and Tax Statement, is provided by the employer. If you receive digital assets in exchange for providing services and you are not an employee of the payer, you are considered self-employed and an independent contractor.
<Example 4>
Tokuo received 10 Bitcoins worth $100,000 for providing his services as an employee. Tokuo must report this 10 Bitcoins as “wages” on his income tax return. If Tokuo is not an employee, his compensation is reported on Schedule 1 or Schedule C. Tokuo must report this income on his income tax return, regardless of whether he receives a Form W-2, Form 1099-MISC, or other information return.
Worthless or Abandoned
Unlike the sale of a digital asset investment that results in a capital gain or loss, a loss due to a digital asset investment becoming completely worthless is an Ordinary Loss. It is important to note that the asset must be completely worthless for this loss to be recognized. Ordinary losses from worthless or abandoned investments are subject to miscellaneous itemized deductions in the year of worthlessness/abandonment but is not deductible on your tax return because the Tax Cuts and Jobs Act of 2017 provides that an individual’s miscellaneous itemized deductions are not deductible in 2018 through 2025.
When are digital assets not taxed?
In general, the same rules that apply to other assets apply to digital assets. Not all asset transactions are taxable. For example, the following transactions are not taxable:
Transactions with yourself
If you transfer cryptocurrency, virtual currency from a wallet, address, or account that you own to another wallet, address, or account that also belongs to you, even if you receive a return of information reporting the transfer; The transfer is a non-taxable event.
Bona fide gifts
If you receive digital assets as a bona fide gift, the gift is not taxable. If you sell, exchange, or otherwise dispose of your digital assets, you must report income or loss. If you gift digital assets, you may need to report the gift on your gift tax return.
Charitable donation
If you donate digital assets to a charity listed in Section 170(c) of the Internal Revenue Code, no income, gain, or loss from the donation will be reported. However, you may be entitled to claim a donation deduction on your income tax return for the year you make the donation.
Soft Fork
A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and therefore the creation of a new cryptocurrency. A soft fork does not result in you receiving any new cryptocurrencies, so you are in the same position as before the soft fork. This means that soft forks do not generate any income.
Record of transactions
Internal Revenue Code and regulations require taxpayers to maintain records sufficient to establish their standing on federal tax returns. Therefore, after you report a taxable event or if you have other reporting requirements, you may be required to make digital assets and fair market purchases, receipts, sales, exchanges, and other transactions of digital assets, even if they are not immediately taxable. Records of dispositions and fair market values of assets or services received in exchange for digital assets must be maintained for at least three years.
Form 1099-DA
Report gross proceeds to brokers, including digital asset trading platforms, digital asset payment processors, and certain digital asset hosted wallet providers, for sales or exchanges of digital assets that take place on or after January 1, 2025. is required. Use the newly developed Form 1099-DA to provide payee statements to your customers.
Summary
Having knowledge about digital assets and taxation will become increasingly important in the future. There are a wide variety of digital assets, including Bitcoin and other virtual currencies, stablecoins, and NFTs, and the tax points associated with them are also different. Trading and owning digital assets require an understanding of calculating capital gains and losses, reporting income from forks and airdrops, and receiving digital assets as a service.
Sales and exchanges of digital assets, receipt of new tokens through hard forks and airdrops, etc. must be properly reported. This ensures compliance in taxable events and understands losses in the event of worthlessness and non-taxable events such as charitable donations.
It is important to maintain accurate information on up-to-date tax laws and regulations and to maintain proper records of transactions involving digital assets. Additionally, when digital assets are received, reporting is required depending on their nature and use. When it comes to tax matters related to digital assets, expert advice tailored to each individual case is also beneficial, and tax matters must be carried out in a well-planned and legal manner.
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