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Virtual Currency Taxation

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Virtual Currency Taxation

The virtual currency taxation is a heavy sea that might be well rough to navigate. Specialized in providing comprehensive solutions tailored to meet your virtual currency taxation requirements, DimovTax offers a range of services designed to ensure compliance and optimization of your tax strategy, as an experienced quartermaster to your ship whether you are:

  • An individual investor;
  • A cryptocurrency trader; or
  • A business operating in the digital asset space.

Our expertise and in depth understanding of the ever evolved tax regulations enable our team to perform the following services specifically for virtual currency taxation needs:

  • Analysis of taxation requirements on virtual currency transactions;
  • Professional guidance on reporting requirements;
  • Comprehensive documentation against complexities.

The Guidance of IRS

The Internal Revenue Service (“IRS”) issued Notice 2014-21 in 2014 and clarified that virtual currency would be treated as property for federal income tax purposes. This notice laid the groundwork for understanding how traditional tax principles apply to transactions involving virtual currency.

The IRS uses the term “virtual currency” in these FAQs to describe the various types of convertible virtual currency used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the terminology, if an asset has a nature of virtual currency, it will be treated as such for Federal income tax purposes. 

Determining Gain or Loss

Applications on the taxation of virtual currency require understanding the definition of holding duration as well as its implications on capital gains or losses. Here’s what you need to know:

  • Short term Capital Gain/Loss: A short term capital gain or loss would be encountered after holding virtual currency for a year or less before selling or exchanging it. 
  • Long term Capital Gain/Loss: Contrarily, holding virtual currencies for more than one year before selling or exchanging results as long term capital gain or loss.
  • Holding Period: The holding period starts the day after acquiring the virtual currency and concludes on the day of its sale or exchange.

For a deeper understanding of short term and long term capital gains and losses, refer to authoritative resources such as Publication 544, Sales and Other Dispositions of Assets.

The Basis

It is essential to understand the concept of “basis” when calculating the gain or loss from virtual currency transactions irrespectively of long term or short term.

The gain or loss is calculated as the difference between the adjusted basis in the virtual currency and the amount received upon its exchange. This information should be included on Federal income tax returns in U.S. dollars.

The term, which is mostly referred as “cost basis,” represents the total amount spent to acquire the virtual currency. This includes not only the purchase price but also any associated fees, commissions and other purchasing costs, all denominated in U.S. dollars. The adjusted basis, on the other hand, is your basis increased by certain expenditures and reduced by specific deductions or credits in U.S. dollars.

Receiving Payment via Virtual Currency for Services Provided

It is important to consider the fair market value of the virtual currency in U.S. dollars at the time of receipt. In an on-chain transaction you receive the virtual currency on the date and at the time the transaction is recorded on the distributed ledger. Understanding these factors is vital for accurate income recognition in virtual currency transactions.

Understanding Tax Implications on the Hard Forks 

Hard forks in cryptocurrency represent significant protocol changes resulting in a permanent diversion from the legacy distributed ledger. Here is what you should know about their tax implications:

  • Hard Fork: A hard fork might lead to the creation of a new cryptocurrency on a new distributed ledger, alongside the existing cryptocurrency on the legacy distributed ledger. 
  • Taxable Income: If the cryptocurrency undergoes a hard fork but there is no cryptocurrency received through an airdrop or other transfer, there is no taxable income.
  • Airdrop Consequences: However, if a hard fork is followed by an airdrop and new cryptocurrency is received, it becomes taxable income in the year that it was received.

If you require further clarification or assistance, please do not hesitate to contact our professionals.

Reporting Obligations

The capital gain or loss should be calculated and the sales and other capital transactions must be reported in compliance with IRS forms and instructions. These reporting obligations include 

  • Form 8949 Sales and Other Dispositions of Capital Assets; and 
  • Form 1040, Schedule D, Capital Gains and Losses.

Ordinary income from virtual currency must be reported on various IRS forms, including;

  • Form 1040, U.S. Individual Tax Return;
  • Form 1040-SS;
  • Form 1040-NR;
  • Form 1040, Schedule 1, Additional Income and Adjustments to Income;

Best Practices on Holding Virtual Currencies

Tax implications on virtual currency are constantly updated by IRS and many questions could be answered by referring to current regulations by our team.

Detailed records on your virtual currency are key to compliance with the laws.

The records should include the following information:

  1. The date of when the virtual currency was received.
  2. The fair market value of the virtual currency on the date of receipt.
  3. The purpose of holding the virtual currency subject to taxation (inventory, investment, etc.)

You may follow multiple virtual currency purchases in separate wallets predominately as these would constitute appropriate records.

In conclusion, virtual currency taxation is a complex subject that demands precision and expertise. At Dimovtax, our professionals are specialized in providing comprehensive services and supporting our clients to comply with all applicable tax requirements. Our tailored approach depends uniquely on the client to navigate virtual currency taxation effectively. Please let us assist you in making decisions based on accurate information and maximize your tax efficiency in this ever-evolving landscape.

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