If you have thought about investing in or using cryptocurrency as an alternative to traditional means of using money, there are many ways that you should educate yourself about how it works, how best to use it, what to avoid, and how to keep track of your investment and finances. Cryptocurrency and your accountant should be synonymous.
In this virtual world that we live in, cryptocurrency has grown in popularity. It is not physical paper or metal-based currency. It is digital in its format. You purchase it, either with a credit card or through a process called digital “mining.” This can be very confusing to the average person who is not accustomed to thinking in virtual terms.
Crypto mining is achieved through a series of equations using a computer to record a blockchain. In a traditional banking system, there is usually one central location where money is processed in a ledger. Money is deposited or withdrawn, and each transaction is recorded. With crypto mining, there is no one centralized location where the “money” is calculated. Cryptocurrency uses an algorithm to verify transactions. Since it is decentralized, there are “miners” who utilize their computers to keep track of and add transactions to the ledger. These miners get a small percentage of the currency as payment for their work.
These miners own and operate their devices as a bank would, except there is no centralized location. Since these crypto miners make money off of each transaction, there is, legally, taxable income to be accounted for to them, and the profits or losses that you incur also have an impact on your taxes.
In 2014, the IRS identified cryptocurrency as something that is taxable as a capital asset. This is much like you would consider any stocks or bonds that you would buy. If you purchase stocks and then you sell them at a profit, you have to pay a capital gains tax. The same holds true if you purchase cryptocurrency and the value increases. It is important for you to report any gains in your cryptocurrency, and your accountant would need to consider it when working on your yearly income tax forms.
The same holds true if you lose money on your cryptocurrency. If you spend it or lose money on your investment, you do not have to pay taxes on it. Your accountant will also advise you of other tax considerations that may include:
- Long-term capital gains – this is when you hold onto your crypto for a year or more. Any profit would be realized at a lower rate, subject to your annual income.
- Crypto as a bonus – if your employer pays you a bonus in cryptocurrency and your accountant is computing your overall income for the year, you owe taxes based on the value as of the day you received it, since you did not purchase it yourself. The same holds true if you received it as payment for goods and services.
- Converting from one crypto to another – once again, depending on the value of the trade, you would owe taxes if you swapped one form for another and saw an increase in value.
Many people feel that cryptocurrency is a good thing to get into. It has a high liquidity, which means it is easy to buy, sell and trade. Because it is algorithm-based, it is easy to ask for a purchase price and let the computers do the rest. They wait for the price you want and then can move in an instant to make the purchase. The same can be said for selling or trading your currency.
Another important aspect of cryptocurrency is that it is becoming more and more mainstream and acceptable as a form of currency for products, services, and as a means of transferring currency in general. As companies are getting more familiar with how it works and the benefits of it, they are offering it as an option for payment.
As a result, many investment companies are suggesting that cryptocurrency should be a part of any investment strategy. Part of a diversified portfolio could include crypto, especially since it is still in the infancy stages and could be a good long-term investment.
The downside to cryptocurrency is just as important to consider, and many accountants discuss these points with their clients:
- It’s hot now, but will it course correct? If you choose to invest in crypto, understand that when an investment is very popular, the cost to invest is high as well. This could lead to the value dropping if too many people get involved or its popularity diminishes.
- It is not regulated. Buyer beware! There are many snake oil salesmen out there who are fraudulently peddling cryptocurrency and then taking your money without ever fulfilling the investment. It is very hard to track these people down, so make sure you are only dealing with reputable companies and check them out before making a trade.
- Hacking the exchange. This is an online transaction that you make through apps and websites. Make sure that your personal information, passwords and bank info is encrypted before making any transactions through online portals.
Keep very good records of your crypto activities and make sure your accountant has the most accurate records so he or she can help you optimize your profits and take advantage of your losses. The new world of investing requires working with CPAs who are aware of the tax laws and can give you advice on the best way to enter the world of cryptocurrency, safely and profitably.
