If you use or hold cryptocurrency, also called virtual currency, you need to exercise special care. Challenges arise from the fact that the IRS classifies all virtual currencies as property, not as currency in the usual sense. As a result, any transaction involving cryptocurrency might involve a capital gain or loss that must be reported to the IRS.
Potentially taxable cryptocurrency transactions include:
In order to calculate the amount of your gain or loss in a virtual currency transaction, you need to know your basis in the virtual currency. If the value you receive when you dispose of the virtual currency is higher than your basis, you must report a capital gain; if the value you receive is lower than your basis, you may be able to claim a deductible capital loss.
The IRS recently issued a number of clarifications on how to determine your basis, including:
Failure to keep detailed records of your cryptocurrency transactions can be costly. For example, if you receive virtual currency as a gift but cannot document the donor’s basis, your basis is zero. Therefore, the full value of any transaction involving that virtual currency may be taxable.
Remember also that short-term capital gains (those that occur within a year of your receipt of the cryptocurrency) are taxed as ordinary income, whereas long-term capital gains are taxed at lower rates. Therefore, it is often advantageous to hold virtual currency for more than a year before disposing of it in any fashion