6 Things RIAs need to know about taxes and crypto
The IRS has seen the crypto headlines. They’re taking notice, and your clients should too.
Estimated reading time: 4 minutes
Millions of Americans have invested in bitcoin and other crypto currencies—likely including some of your clients and prospects. If your clients have heard that crypto isn’t taxed, they could be in for an unpleasant surprise at tax time. While investors should always consult their tax professional for advice, here are a few things to keep in mind.
1. Be sure clients report income from crypto transactions
With a conventional taxable brokerage account, the custodian issues your client one or more IRS Form 1099s after the end of each tax year that provide certain key tax information such as income earned and information regarding capital gains. The custodian also sends a copy of the 1099s to the IRS, closing the loop.
Many of the largest crypto trading platforms and custodians, however, do not currently issue 1099s. Because the reporting is less consistent, an uniformed client may assume that income from crypto transactions is not reportable or taxable. That, of course, is not the case; income can be reportable and taxable regardless of whether it is captured in a 1099. A filer’s tax return requires, on IRS Form 1040, reporting of sales or exchanges of virtual currency, including crypto, even if an individual does not receive a 1099. Further, clients should be aware that the IRS has made going after unreported crypto income a priority. Every crypto transaction leaves a digital footprint —so the trail is there, should they decide to look for it—and the IRS has the ability to subpoena exchanges and trading platforms to collect client information. Your clients should be sure that they report all crypto-related income, and work with a qualified tax professional if necessary to assist with understanding and complying with these requirements.
As with many aspects of crypto, rules and regulations are quickly evolving. The infrastructure bill recently signed into law requires reporting on 1099-B starting in 2024. Advisors themselves may need to follow similar developments and consult with tax professionals as things change.
Flourish Crypto clients already receive 1099-Bs, which are also reported to the IRS, each year, keeping things simple for clients at tax-time.
2. Capital gains and losses
A 2014 IRS ruling determined that crypto should be treated like a capital asset in the same fashion as stocks, bonds, mutual funds, and ETFs —making it straightforward to understand how the asset is treated. The holding periods for the classification of gain or losses as long-term or short-term are the same as for many other capital assets.
3. New ways of triggering taxes
Besides serving as an investment, cryptocurrencies such as bitcoin can also be used as a payment method. If your client uses crypto that has appreciated in value since they acquired it to pay for a purchase, however, the difference between the crypto’s acquisition cost and the value on the date the payment was made will be treated as a capital gain. In the eyes of the IRS, there is no difference between using the crypto to make a purchase or selling it as an investment.
Beyond trading or using crypto to make a purchase, other types of transactions can potentially trigger taxes:
- Mining: If your client receives payment for mining in the form of crypto, the crypto that the client receives is ordinary self-employment income calculated as the fair market value of the crypto at the time of receipt. That amount will be their basis for that crypto lot.
- If they receive payment for goods or services in the form of crypto, this payment could be taxed as ordinary income. This includes crypto received for a marketing promotion or an airdrop, which are free coins sent for the promotion of a new cryptocurrency token. Starting in 2024, businesses that receive payments of $10,000 or more in crypto must report the transaction to the IRS, including the identity of the sender, under new rules in the infrastructure bill.
4. Tax Lots
As with stocks, ETFs, and other investments held in taxable accounts, it's important for your clients to keep track of their crypto tax lots. This can help them minimize taxes in situations where they need to sell some of their crypto or use it to make a purchase by avoiding selling crypto with large gains. They can also use tax lots that might show a loss as part of a tax-loss harvesting strategy as with any other investment asset.
Unlike stocks, ETFs, and mutual funds, virtually no prominent retail trading platforms track tax lots automatically, so clients may need to keep their own careful records.
5. Wash Sale Rule
One major positive? The Wash Sale Rule does not currently apply to virtual currencies, including bitcoin. The Wash Sale Rule normally prohibits the sale of a security for tax loss purposes if the seller then repurchases the same (or substantially the same) security within 30 days. However, because “virtual currencies have not been determined to be a “stock” or “securities” judicially, statutorily, or by the IRS for federal tax purposes, the Wash Sale Rule does not apply.”1
That means if clients want to have crypto in their portfolio, but also want to realize crypto losses to offset their tax liability, they can sell and immediately re-purchase at any time without penalty. While this rule may change in time, the flexibility can be a significant benefit to owning crypto directly today, as opposed to through a fund or trust structure.
6. Taxable vs. tax-advantaged accounts
For some clients, it might make sense for them to own crypto inside of an IRA or other tax-advantaged retirement account. Unfortunately, these account types are still relatively rare within crypto investing, although options are steadily increasing. A self-directed retirement custodian that offers IRAs, SEP-IRAs or Solo 401(k) accounts could be a good solution for some clients if fees and complexity are reasonable, although advisors and clients should be aware of trade-offs of potentially converting long-term capital gains to income tax, or losing the ability to tax loss harvest.
Bitcoin and other cryptocurrencies are growing in popularity among many investors. The rules around the taxation of cryptocurrencies are complex and evolving, so clients should be encouraged to consult with a qualified tax professional for assistance. Advisors should check in to make sure that clients are including crypto in their tax reporting to help clients avoid unpleasant surprises at tax time.
FAQs on the tax treatment of virtual currency transactions are available here on the IRS website.