Now that all taxpayers must answer the digital asset question on their tax forms, it’s wise to learn what exactly a digital asset is and isn’t as it relates to taxes.

The IRS defines digital assets as any “digital representation of value that is recorded on a cryptographically secured, distributed ledger or any similar technology.” Clear as mud? The agency’s Taxpayer Advocacy Service goes further by explaining that, “In the broadest sense, a digital asset is an item that is created and stored digitally, has value, has established ownership, and is discoverable.”

Examples given by TAS include:

Convertible virtual currency and cryptocurrency, including Bitcoin.
Stablecoins, including Tether.
Non-fungible tokens (NFTs), including CryptoPunks.

You may have gotten in on the action in recent years. It’s estimated that one in four Americans and 55% of investors own Bitcoin alone. Receiving payment in cryptocurrency is globally accepted, particularly among younger generations. And the NFT market soared in 2021. If you’re unsure whether you own taxable digital assets, ask a trusted tax professional.

When it comes to tax treatment, the IRS draws a hard line: Despite names like cryptocurrency and virtual currency, and most having an equivalent value in or acting as a substitute for real currency, digital assets are “not a real currency.” Instead, the IRS views digital assets as property, assigning capital gain or loss treatment to taxable transactions.

On the current tax forms, you must answer “Yes” or “No” to the question:

At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?

For those who owned digital assets, you may answer “No” only if you had no transactions at all (they stayed in one place), transferred from one wallet or account in your name to another in your name, or purchased the asset using real currency.

All other digital asset owners will likely need to answer “Yes” and then report the assets on the applicable tax form. In most cases, you must consider your potential capital gain or loss for the year (whether it is a short-term or long-term gain and what the basis is, for instance). For those who were paid virtual currency as a form of wages, that income must be reported on Schedule C of Form 1040. Donations and gifts of digital assets must also be reported.

Don’t rely on whether or not you receive a form from a crypto brokerage platform. They aren’t yet required to send forms. The IRS is working on a draft Form 1099-DA for 2025, but it’s likely to get plenty of pushback. Feel free to contact us with questions.

Photo from 123rf.com

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