Cryptocurrency has been disrupting the global financial system since 2009 when the first Bitcoin came into existence. Everything from supply and demand and government regulations to social media attention and investor sentiment affects the value of these digital currencies. So fluctuations in value can be significant, from year to year, month to month, or even day to day.
For example, if you purchased 100 Bitcoin in 2011, it would have cost about $100. By November of 2021, when the price of Bitcoin reached its highest, that same investment would have been worth a little over $6 million. Fast forward to mid-day on October 11, 2022, and the value would have dropped to a little less than $2 million.
In Cryptocurrency Part I: What It Is & Why It’s Important, I shared information about the history of cryptocurrency, went over some of the most popular types, and covered some federal tax implications. I am continuing the tax conversation in Part II to include additional investor considerations, recent legislative updates, and insights on using cryptocurrency in company transactions.
Tax Implications for Cryptocurrency Investors To Consider
Cryptocurrency is considered property for tax purposes, so the realized change in value is subject to capital gains tax. If cryptocurrency is held as an asset for less than one year, any realized gain will be subject to ordinary tax rates. For the 2022 tax year, ordinary tax rates range from 10% to 37%, depending on filing status and income. If the cryptocurrency is held as an asset for longer than one year, a realized gain will be subject to long-term capital gains rates ranging from 0% to 20%.
If a capital loss occurs, the taxpayer may deduct the loss and realize a net loss of up to $3,000 each year. However, their net losses must be carried over to the next year if they exceed the limit.
In Part I, I discussed the “wash sale” loophole, which allows certain taxpayers to sell an asset at a loss, use the loss to offset other gains, and repurchase the asset afterward. However, the most recent wash sale rules exclude cryptocurrency. In addition, Congress is working to close the loophole entirely.
For the 2022 tax year, cryptocurrency gifts of more than $16,000 will be subject to federal gift tax. If the recipient of a gift later sells the asset, their cost basis for tax calculation will remain the same as yours as the gift giver. In 2022, inherited cryptocurrency will be subject to estate taxes if the estate exceeds $12.06 million. Your heir’s cost basis for tax calculation will be stepped-up to the fair value of the cryptocurrency on the day of your death.
Additional Considerations for Business Owners
Before accepting cryptocurrency as payment for a company, the business owner should consider the potential financial risks and tax implications. Namely, think about what receiving a fluctuating currency could mean. A payment worth $10,000 today could be worth $5,000 tomorrow. If cryptocurrency is paid as part of an M&A contract, you have to consider partnership interest and issuances.
When cryptocurrency assets are held at year-end, businesses may have recognition issues. Recognition is based on the fair market value of the cryptocurrency, which can be difficult if the virtual currency is not listed on an exchange or if different exchanges show different values for the same cryptocurrency. Specific reporting rules also exist for like-kind exchanges. For example, Bitcoin, Ether, and Litecoin cannot be exchanged for each other in a like-kind exchange.
Converting to stablecoins may help some businesses preserve revenue margins and keep some passive investment companies from holding on too long. Stablecoins are centralized, and their value is linked directly to a currency or commodity. Because they are less volatile, stablecoins may be less likely to result in capital gains or losses. And for passive investors, stablecoins may provide a safer alternative. While some traditional assets can be held with a reasonable expectation for their value to grow exponentially over time, many digital assets are far less predictable.
LGA’s Individual & Family, Business, & International Tax Teams are here to help. If you’d like to learn more about cryptocurrency or have questions about the tax implications of your digital assets, contact me today.
by Derek Silveira, CPA, MST
Derek is a Tax Partner with LGA. He joined LGA with the merger of Vasil Dowd Silveira, CPA’s in 2019. He brings a personal and understandable approach to complex and far-reaching tax situations. His experience includes working with individuals, multi-state companies and in-bound foreign entities, and on business taxation issues for flow-through entities and their owners.