Crypto Tax Rules: What You Need to Know When Preparing Your Returns in 2022

Cryptocurrency investing exploded in popularity in 2021, and apps like Coinbase and Robinhood make it easy for individuals to invest in the digital currencies of their choosing. Unfortunately, it appears that many people jumped into cryptocurrency investing without giving due consideration to the tax implications involved. Cryptocurrency trading is a taxable activity, and buying and selling coins can result in substantial liability to the Internal Revenue Service (IRS). In this article, Boston tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, explains some key principles investors need to keep in mind when preparing their returns in 2022.

Cryptocurrency is Considered “Property” for State and Federal Income Tax Purposes

Beginning with the fundamentals, cryptocurrency is considered a form of “property” for state and federal income tax purposes. This is important because it means that digital coins are treated differently from fiat currencies. Instead, the tax treatment for cryptocurrency is more akin to the tax treatment for stocks and other securities. If you buy cryptocurrency and then sell it at a profit – or even exchange it for another type of crypto – this is a taxable transaction that you must report on your annual returns.

Realizing Gain or Loss is the Primary Triggering Event for Tax Consequences

Tax consequences come into play when a cryptocurrency investor realizes gain or loss. If you bought cryptocurrency in 2021 with U.S. dollars and you still have this cryptocurrency in your digital wallet, then you have not realized any gain or loss. But, if you sold or exchanged any of your cryptocurrency in 2021, this transaction had tax consequences—and you need to appropriately disclose these consequences to the IRS.

In this regard, an important concept to keep in mind is the “highest in, first out,” or “HIFO,” accounting method. Let’s say you bought Bitcoin in two separate transactions—first at $50,000 per coin and then at $35,000 per coin. If you sold half of your holdings before the end of 2021, HIFO allows you to report the sale of your more-expensive Bitcoin (resulting in a loss) instead of reporting income on the Bitcoin you purchased for $35,000.

Failing to Report Cryptocurrency Transactions Can Lead to Trouble with the IRS

Regardless of whether you profited or lost money with cryptocurrency in 2021, you need to accurately report all relevant transactions to the IRS. If you don’t, you could find yourself the target of a cryptocurrency tax audit or investigation. Underreporting your cryptocurrency-related tax liability is a violation of the Internal Revenue Code, and it can potentially lead to civil or criminal penalties.

Request a Cryptocurrency Tax Consultation with Boston Tax Lawyer Kevin E. Thorn

If you have questions or concerns about reporting your cryptocurrency-related tax liability to the IRS, we can help. To schedule a confidential consultation with Boston tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, please call 617-692-2989, email ket@thornlawgroup.com or request an appointment online today.