If you're cashing in some of your Bitcoin this year, the IRS wants to know about it.
On Monday, the cryptocurrency's value hit new heights, surging beyond $19,800 for a unit of Bitcoin. The asset's appreciation has skyrocketed this year, rising by 160% in 2020.
Understand that if you want to take a few of those holdings off the table, you'll need to share that information when you file your individual income tax return next spring.
In fact, the IRS gets right to the point, asking on the first page of the income tax return, or Form 1040, "At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?"
You'll have to check yes or no.
"The first thing with cryptocurrency is that, if you have crypto transactions, you'll need to report them," said Andy Phillips, director of the Tax Institute at H&R Block.
"The question is front and center — the first thing that they touch on Form 1040," he said.
People who transacted with virtual currency aren't the only ones who'll be checking the yes box on their 1040 next year.
If you received any crypto for free, you're still expected to check yes on the front of your tax return, according to newly released draft instructions from the IRS.
Exchanged some virtual currency for goods and services or for other property — including different cryptocurrency? You still need to answer yes.
You'll also need to keep records of your transactions, which can get tricky if you're using multiple exchanges or different types of cryptocurrency.
"People have multiple exchanges and the more spread out the cryptocurrency is, the more challenging it is to gather it together and do your calculations," said Kirk Phillips, CPA and member of member of the American Institute of CPAs' Virtual Currency Task Force.
The IRS considers virtual currency to be property — the same way it treats stocks or other investments.
This way, if you bought some Ethereum and then sell it or if you swap it for something else, you've incurred a capital gain or a capital loss. If you captured a gain, then you're responsible for taxes.
Here's where things can get confusing: Major cryptocurrency exchanges may provide taxpayers with a Form 1099-K with these details — if they've had gross payments exceeding $20,000 and they've made more than 200 transactions.
"That threshold is so high," said Phillips at H&R Block.
"A lot of taxpayers either don't do a lot of transactions," he said. "Or if they do many of them, they use multiple exchanges and don't hit the threshold on any one exchange."
Even if you're below the threshold, you're still required to report the transaction and pay taxes owed.
Virtual currency from an employer is treated like wages.
If you mine cryptocurrency, you're also required to include it in your taxable income. You would include the fair market value as of the date you received it.
The IRS has been cracking down on unreported transactions in recent years. Last year, the agency sent letters to more than 10,000 taxpayers with virtual currency transactions, telling them to pay back taxes and file amended returns.
Failing to report income can carry hefty penalties and interest. In the worst case, you could go to prison and be fined up to $250,000.
Transacted in virtual currency this year? Know three key points: the fair market value of at the time of the transaction, your basis — the amount you originally paid when you acquired the asset — and the holding period.
"If the holding period is greater than one year, it's considered long-term capital gains," Mark Luscombe, CPA, principal federal tax analyst at Wolters Kluwer Tax & Accounting. "If it's less than one year, it's ordinary income."
The difference in tax treatment is stark: Long term capital gains are subject to rates of 0%, 15% or 20%, while ordinary income rates can be as high as 37%.
Several software providers have emerged — including LukkaTax and Bitcoin.Tax — to help individuals keep track of their transactions and basis.
Expect the taxman to take a hard line with compliance around crypto.
"Once you know the IRS has access to the information, it's better to come into compliance before they come calling," said Luscombe.