One theme of our publications to date has been the need for individuals participating in the virtual currency space to keep meticulous records. Aside from being necessary for accurate tax reporting, quality records will allow an individual to dispose of crypto positions in a tax efficient manner. The default method for determining the ordering of how units of an individual’s crypto position are disposed is the FIFO (first in, first out) method of accounting. This means that crypto positions are disposed in chronological order beginning with the earliest unit of an individual’s crypto position. However, the IRS is clear that an individual can identify specific units of virtual currency and dispose the individual’s virtual currency in whatever order the individual wishes so long as certain criteria are satisfied. The remainder of this article examines how an individual can identify a specific unit of virtual currency.
In order to identify a specific unit of virtual currency an individual must show:
- The date and time each unit was acquired
- The basis and fair market value (FMV) of each unit at the time of acquisition
- The date and time each unit was disposed
- The FMV of each unit when disposed and the amount of money or the value of property received for each unit
The first two requirements needed to identify a specific unit of crypto relate to when the holding period begins. The final two requirements needed to identify a specific unit of crypto, which are essentially identical to the first two requirements, relate to when the holding period ends.
Requirement One - The Date and Time Each Crypto Unit was Acquired
For an individual who acquired virtual currency through a modern exchange the date and time of a crypto transaction are easily accessible by viewing the user’s transaction history. Furthermore, the exchanges we are aware of provide an email confirming the transaction that includes the date and time of the transaction. The confirmation email is a useful backup and should always be saved by an individual. During the course of the crypto currency evolution many exchanges have gone out of business or stopped operating in the United States. The more control an individual has over the necessary documentation to be able to identify a specific crypto unit, the better. Thus, an email record of a transaction which an individual has full control over is extremely useful.
An individual acquiring virtual currency through another medium besides a crypto exchange, such as through direct payment from another crypto wallet, will have to do a little more diligence to find the date and time of the crypto transaction. However, all crypto wallets we are aware of provide a time stamp and date for each transaction. In most circumstances, the date and time each unit of virtual currency was acquired should not be challenging for an individual to verify.
Requirement Two – The Basis and FMV of Each Crypto Unit at the Time of Acquisition
Next, the individual will have to show the basis and FMV of each unit of virtual currency at the time it was acquired. In most situations, an individual’s basis and FMV will be the same when the crypto currency is acquired. One exception to this occurs when crypto is received as a gift (a topic that we will address in a future publication given the rarity of this situation and its complexity as different rules apply depending on whether there is a gain or a loss). Again, for an individual who acquired virtual currency through a modern exchange, this information should be easily accessible. As was the case with the first requirement, the confirmation email sent by the exchange will also contain the basis and FMV of the crypto position acquired making the confirmation email important to save.
It is vital that a user have access to the specific amount of the virtual currency acquired with each transaction along with the dollar amount paid. For example, if an individual is acquiring bitcoin on an exchange, the number of satoshis as well as the amount paid for the transaction will be necessary. A bitcoin is made up of 100,000,000 satoshis. One ether is made up of 1,000,000,000,000,000,000 weis. The more specific information an individual has, the better. Admittedly, there is diminishing return with some of the details of certain cryptos such as ether’s smallest unit of account, the wei. The more detail the better but if you are talking about units of account smaller than the value of $0.01, the detail is probably unnecessary no matter how much you think the crypto currency will go up in the future.
An individual who acquired a crypto position through a medium other than an exchange, such as through a direct payment from another crypto wallet, will need additional supporting documentation. A review of the bitcoin and ethereum blockchains reveal that the blockchain only records the unit of account of that specific crypto currency. The blockchain does not reveal any information related to US dollars or any other fiat currency for that matter. Therefore, it is critical for an individual involved in a transaction using a crypto wallet to have a receipt which records the US dollar amount involved in the transaction. For simplicity the transaction receipt should have the time, date, specific amount of crypto involved in the transaction, and the US dollar amount being received. Documenting the receipt in a manner that there is a timestamp, such as through email, will be helpful to assure the IRS the documentation was not backdated.
Requirement Three – The Date and Time Crypto Each Unit was Disposed
The third requirement is similar to the first requirement except it is inquiring about the time and date the crypto was disposed rather than acquired. As discussed above, an individual electing to dispose of a crypto position on a modern exchange should be able to access this information by viewing the user’s transaction history. An individual disposing virtual currency through a direct payment from his/her own crypto wallet should have access to this information in his/her transaction history.
While a user may think he/she will always be privy to this information, remember that the individual is almost certainly not filing his/her taxes at the same time the transaction occurs. For instance, a taxpayer may dispose of a crypto position in January 2021 and not have to report the transaction for tax purposes until April 2022. That is a significant lag time. Therefore, having organized documentation of the time and date of each transaction, preferably with backup supporting data, is a best practice.
Requirement Four – The FMV of Each Crypto Unit when it was Disposed and the Amount of Money or the Value of the Property Received for Each Unit
The fourth requirement is similar to the second requirement except it is inquiring about the FMV of each unit of crypto and the amount of money or the value of property received for each unit of crypto at the time it was disposed rather than acquired. Again, for an individual using an exchange for the transaction, this information should be easy to find by locating the transaction history. As was the case for acquiring a virtual currency, an exchange will provide a user a confirmation email when a crypto position is disposed of from the exchange. The confirmation email should include the date, time, the specific amount of crypto that was moved (i.e. bitcoin, ether, etc.), and the total amount of money received. An individual can determine the amount of money received for each unit by taking the total amount of crypto received and dividing it by the total amount of USD in the transaction.
An individual who disposed of a crypto position through a medium other than an exchange will need additional supporting documentation. As discussed with requirement two above, the blockchain data only records the unit of account of that specific crypto currency and not the US dollar amount or any other fiat currency. Therefore, as was the case with requirement two, it is critical for an individual involved in a transaction using a crypto wallet to have a receipt, preferably electronically time stamped, which records the US dollar amount involved with the transaction.
Conclusion
To tax efficiently dispose of an individual’s crypto positions the four requirements discussed above must be readily available to an individual. An individual should keep meticulous records of all of his/her crypto positions. While modern exchanges have made the recordkeeping task simpler than the early days of crypto, individuals should store and organize the records for which they have total control, such as confirmation transaction emails. An individual conducting transactions through a crypto wallet will need to create documentation, preferably with an electronic timestamp, that assists the individual to satisfy the four requirements discussed in this article. If you have any questions regarding the topics discussed in this article, please contact us.
