Cryptocurrency and Your 2019 Tax Return – Handle With Care

It’s been no secret that cryptocurrency is in the  crosshairs of the Internal Revenue Service (IRS).  Virtual currency is one of the IRS “campaigns” and criminal investigations related to crypto already started last year.  Taxpayers are being sent “educational” letters to remind them and warn them of their tax obligations when it comes to the use of cryptocurrency.

2019 Tax Return and Crypto

The IRS recently released three important items relating to the use of cryptocurrency. Taxpayers and tax pro’s have to be up to speed when preparing and filing the 2019 tax return in order to not fall foul of these important IRS announcements.

Let’s look at what the IRS has said about cryptocurrency ownership and use to make sure that the 2019 tax return does not miss the mark:

Revenue Ruling 2019-24

In October of last year, the IRS released Revenue Ruling 2019-24 that specifically addressed the tax consequences associated with “hard forks” and “airdrops”.  For those of you who are unfamiliar with these terms, please read my tax blog post here, which provides a crypto primer and fully discussed the Revenue Ruling.

Hard forks (essentially, a shift resulting in a “new” cryptocurrency) and airdrops (e.g., a “free” coin) are often auto-generated promotional tools used by the cryptocurrency organization.  They generally do not involve the taxpayer taking action to receive them. This means, for example, that a taxpayer who received an airdrop for free from the organization must deal with US tax issues and a hidden tax price tag.  To make matters worse, the revenue ruling has retroactive effect meaning that taxpayers and their return preparers must carefully evaluate the cryptocurrency transactions that occurred in the past.  Amended tax returns may need to be filed along with payment of additional tax, interest and possibly penalties.  The IRS has not provided any transition relief in this situation, much to the dismay of tax professionals.

IRS FAQ Guidance

The IRS has issued “Frequently Asked Questions” addressing numerous issues dealing with cryptocurrency, including those related to calculating income, gains and losses, basis calculations, gifting and charitable donation transactions, recordkeeping and much more.  The FAQs are updated and revised by the IRS so this is a helpful document, but remember, it cannot be relied upon! FAQs are not authoritative pronouncements by the IRS unless they are published in the Internal Revenue Bulletin. So, while helpful, FAQ talk is cheap.

A New, Probing Question on Form 1040

Form 1040 Schedule 1 for 2019 tax returns shows how serious the IRS is about reporting cryptocurrency. The very first question on Schedule 1 asks, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?”  Taxpayers must check a “yes” or “no” box.

Diligent tax return preparers should be asking clients about cryptocurrency and should have added this question to an updated tax organizer.  If your return preparer has not done so, you should be questioning if you have the right preparer.  It is suggested that in reporting crypto transactions very close adherence is paid to the information the IRS has recently provided.  A conservative approach may be the better path given the current heat on crypto.  Finally, make sure there is adequate documentation to support positions taken, including how gains and losses were calculated.

The American Abroad and Crypto

Many Americans living and working abroad have found it difficult to maintain a bank account in their country of residence due to the infamous “Foreign Account Tax Compliance Act”, FATCA.  These individuals may more frequently turn to cryptocurrency to handle payments as more and more goods and service providers are becoming happy to accept it.

Unfortunately, Americans overseas are already in the IRS cross-hairs with respect to their foreign assets or accounts. Adding crypto to the mix, may just make matters more precarious.  In an attempt to track digital currency transactions, the IRS has entered into a license agreement to use software to identify the owners of digital wallets.  Identifying crypto owners is really happening and the biggest criminal takedown involving Bitcoin took place last October….. if you think you are safe because you are using cryptocurrency, think again.

Posted January 30, 2020

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