Oh, well look there I go I see it is the top of the hour. For those of you just joining us welcome to today's webinar, Taxable Transactions with Digital Assets. You know we are really glad that you joined us today. My name is Veronica Tubman and I am a Senior Stakeholder Liaison with the Internal Revenue Service. And I will be your moderator for today's webinar, which is slated for 60 minutes. You know this webinar offers up to one IRS continuing education or CE credit. Certificates of completion will be email to the registration address of qualifying participants. We email certificates from the email address seen on this slide, CL.SL.Web.Conference.Team@IRS.gov. Please add this email address to your contacts to ensure you receive the email with the certificate and the PDF attachment. Before we begin if there's anyone in the audience that is with the media, please send us an email to the address on the slide.
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The webinar is scheduled for approximately 60 minutes from the top of the hour. So, let me introduce today's speaker. I have the pleasure of introducing Jennifer Kaiser, Jennifer is a graduate of Arizona State University with a Bachelor's in Accountancy. She has been with the IRS for 22 years. For the last 6 of those years she has been working in the Digital Asset space. She currently serves as a Digital Asset Analyst in the Digital Asset Program Office. She has previously held roles as a Digital Asset Tech Advisor and Small Business Self-Employed Field Examiner.
I am going to turn it over to Jen to begin the presentation. Jen? Thanks Veronica and good afternoon everyone. I'm going to go ahead and jump right in. The objective of our presentation is to help you in identifying taxable events that involve digital assets, calculating income, gains and losses associated with digital asset transactions and reporting income gains and losses associated with taxable digital asset transactions for individuals filing Form 1040 and Form 1040-SR tax returns. So let's begin the presentation. We will start today's presentation by discussing how to identify taxable events involving digital assets. Let's define digital assets. What are digital assets? The terminology is used by the IRS to describe assets like Bitcoin that has evolved from when that whitepaper was released in October 2008.
The first piece of guidance released by the IRS with respect to assets such as Bitcoin was Notice 2014-21. This Notice used the term, convertible virtual currency to describe Bitcoin. This makes sense because Bitcoin and similar tokens were primarily used as a payment mechanism, not as legal tender. At that time you could send, receive and hold Bitcoin, but that was pretty much it in general. Since the Notice was issued in 2014, a lot has changed in this space.
So for example Ethereum blockchain launched in 2015 and that has been followed up with on-chain applications such as Decentralized Finance protocols or DeFi, stablecoins and Non-Fungible Tokens or NFTs. Bitcoin became a legal tender in some jurisdictions, which then necessitated the issuance of Notice 2023-34, which modified the 9-year-old Notice 2014-21 that I mentioned earlier that said otherwise. As you can see, this asset class has evolved into many more use cases and applications beyond just sending and receiving and holding payments. Observing these changes in this new asset class, when Congress enacted the Infrastructure Investment and Jobs Act or IIJA back in November 2021, it used the term "digital assets" to describe Bitcoin, Ether, Non-Fungible Tokens and similar tokens for purposes of the expansion of the section 6045, Broker Reporting Provisions.
The IIJA defined digital assets as "Any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary" as you can see on the screen. Simply put, a digital asset is a token that exists on a blockchain. Now I'm going to cover digital asset transactions.
So let's look at some of the general federal tax concepts applicable to digital asset transactions. First, digital assets are treated as property for federal income tax purposes, not as foreign currency. This means that federal income tax principles that are applicable to property transactions are going to apply to digital assets. And while the purchase of digital assets with cash is not a taxable event, the receipt of digital assets as payment for goods or services in the ordinary course of business is a taxable event. This is no different than if the taxpayer received other types of property for goods or services. The amount of ordinary income that should be reported by a taxpayer receiving digital assets for goods or services is equal to the fair market value of the digital asset at the time of receipt.
This is generally when the taxpayer first has dominion and control over the digital asset. When the taxpayer sells digital assets for cash or other property and that includes other digital assets or uses digital assets to pay for goods and services, this is a taxable event. Assuming the digital assets are capital assets in the hands of the taxpayer, then that's generally can result in a capital gain or loss. And if the taxpayer receives digital assets as a payment for goods or services in the ordinary course of business, this will result in ordinary income for the taxpayer.
Let's talk about Form 1040 digital asset question. I'm sure you are all familiar with the digital asset question that takes up prime real estate on the Form 1040.The language used on the Form 1040 reflects the evolution and the terminology used to describe this asset class. As I mentioned at the beginning of the presentation, it has gone from convertible virtual currency to the current terminology of digital assets. For the 2023 tax year in particular, the digital asset question reads, 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}?, and points the taxpayer respondent to the instructions for more information.
The IRS has received a lot of feedback on this question since it was introduced back in 2019, where at that time the question started out on Schedule 1 of the 1040 and then it moved, back in 2022, where you see it now. A general rule of thumb is that if a taxpayer transacted in digital assets during the tax year they should probably answer, yes, to that question. However, there are some limited circumstances that would not require a, yes, to this question. But first let's discuss when to say, yes.
So, when would a taxpayer check, yes, in general they would check, yes, when they have received digital assets as payment for property or services that are provided. So let's say if you prepare your client's tax return and in return they give you digital assets as payment, then you would check, yes. If they have received a digital assets from a reward or award, this could be, there could be various reasons why someone would receive a reward or award in digital assets but in general an example would be that some centralized exchange may have some kind of program in which they award digital assets for a particular action like watching a video or reading something and if that were to happen, then, and someone was to receive a digital asset as a reward or award as the result of that then you would check, yes. When receiving digital assets resulting from a hard fork A hard fork in general is a branching of a cryptocurrency's blockchain that splits a single cryptocurrency into two and which an in-depth explanation of is definitely beyond the scope of today's presentation. But anyways, when this happens there may be an award of a new asset.
So for example you may or may not be familiar but one of the more notable examples is back in August 2017 when Bitcoin had a hard fork and split into Bitcoin and Bitcoin Cash, the holders of Bitcoin that received Bitcoin Cash from the split would have checked the yes box. So continuing with when to check yes, when receiving a new digital asset resulting from mining, staking and similar activities, if you are mining Bitcoin and you received a reward, or if you say, have Ether staked and you were awarded Ether, then you would check yes. Disposing of digital assets in exchange for property or services an example of this would be if you paid the preparer of your tax return with digital assets that you owned. Since you disposed of your digital assets when you paid your preparer with them.
You would check yes. Disposing of a digital asset for another digital asset, this would be like if I had Bitcoin but I wanted Ether so I wanted Bitcoin and not cash to purchase the Ether. I have now disposed of some of my Bitcoin in the purchase of that Ether, and therefore because I have that disposition I would check yes even though it's for another digital asset or for another property. If you sold a digital asset, it is pretty explanatory, you check yes, or if you otherwise dispose of any financial interest in a digital asset again another catchall if you dispose of something if you disposed of it you would check yes. So let's look at answering, no. Now, when would you check no.
Normally a taxpayer who merely owned digital assets during the tax year can check the No box as long as they just owned them and did not do anything else. They can also check the No box if their activities were limited to one of the following again only holding digital assets in a wallet or account. That is similar to just having cash sitting in your wallet. Nothing is happening. If that is all that was done through the whole year, you check No. Transferring digital assets between accounts or addresses that are controlled by the taxpayer, this is similar to taking the cash out of one of your pockets or your wallet and putting it into your other pocket or wallet. However there's a little bit of a caveat here. When you are transferring your digital assets from one place to another most likely there's going to be fees involved. How you pay those fees determines if you would check yes or no.
So the actual transferring like I said you would check no. You're just moving it. But there's no, there is no disposition and if that fee is paid with Fiat or US dollars you still check no because still all that is happening is that you are moving and paying with US dollars which is not property. But the fee could have been paid with digital assets. So you are transferring your Bitcoin and the platform you are doing so on charges you a fee, instead of you paying with US dollars, they take it out of your Bitcoin and if that is the case, your disposing of your interest in the digital assets that are paying that fee and you would be back to checking yes because now your disposing of your interest in some of the digital assets that you owned.
For our example today that we are going to go through you can assume that either there are no fees paid or that the fees that were paid are in US dollars. And then purchasing, lastly purchasing digital assets using US dollars or other fiat currency, just purchasing it, purchasing a digital asset nothing else that results in checking No. And it looks like, Veronica I see it is time for the first polling question. I will turn it over to you. Jen, yes it is. Okay audience time for the first polling question an example of a transaction that would require a Yes to the Form 1040 digital asset question is A, holding digital assets in a wallet or account, B, receiving digital assets as payment for property or services provided, C, transferring digital assets between accounts or addresses controlled by the taxpayer or is it D, none of the above.
So take a moment and click the radio button that best answers the question. and I will give you a few more moments to make your selection. Think about what Jen just shared with us. Okay we are going to stop the polling now. And let's share the correct answer on the next slide. And the correct answer is B, receiving digital assets as a payment for property or services provided. And I see that wow, 91% of you responded correctly. Good job. Jen back to you to share examples of questions to ask clients. Thanks.
Again if a taxpayer transacted in digital assets, they would likely respond Yes to that question and here are some examples that you can ask your clients or if you are listening to this for your own knowledge, then it could help you when you are preparing your own tax return. Have you bought or sold any digital assets?; Have you received any digital assets as a form of payment for goods or services rendered?; Have you transferred any digital assets from one wallet or exchange to another?; Have you staked any digital assets to earn staking rewards? And we will continue with examples of questions to ask clients on the next slide.
Have you used any digital assets to purchase goods or services during the tax year? Think of that proverbial cup of coffee that might not be in the forefront of yours or their mind. Have you mined any digital assets during the tax year; Have you engaged in any other digital assets transactions that you think may be relevant for tax purposes. Again this is for the whole year, so something that happen in January might not be on someone's mind when preparing their taxes next year. So, those questions can help.
Moving on to calculating and reporting income. Now that we have identified what constitutes a taxable event with digital assets we will look into how to calculate income gains and losses as well as how to report those on the individual Form 1040 or 1040-SR. Now I'm going to cover capital gains and losses. Notice 2014-21, which was the first piece of guidance issued by the IRS relating to digital assets provides that convertible virtual currency is treated as property for federal income tax purposes. So therefore, tax rules applicable to property transactions also apply to transactions in digital assets.
This means that if the digital asset is a capital asset in the hands of a taxpayer, selling that digital asset will result in a capital gain or loss. The capital gain or loss is calculated by comparing the amount realized, which is what you receive in return for selling that asset, less your adjusted basis in that asset. This analysis is similar to other types of property such as traditional equities. We will talk about how to analyze exchange records to determine the taxpayer's amount realized and adjusted basis later in the presentation. If you held that digital asset for longer than one year, that will result in a long-term capital gain or loss, and if you held it for less than one year, that will result in a short-term capital gain or loss.
Let's move on to ordinary income. Notice 2014-21 and the related FAQs that you can find on the digital assets page on IRS.gov provide that if the taxpayer performs services and receives compensation in the form of digital assets in the ordinary course of business then that results in ordinary income for the taxpayer. And Veronica it's time for our second polling question. Why, yes it is. Okay audience time for the second polling question. Digital assets received for performing services result in, A, long-term capital gain at the time of receipt, B, short-term capital gain at the time of receipt, C, ordinary income at the time of receipt or D, none of the above. So take a moment and click the radio button that best answers the question. And I will give you a few more seconds to make your selection.
So think about the question. Okay we are gonna stop the polling now and let's share the correct answer on the next slide. The correct answer is C, ordinary income at the time of receipt. I see 94% of you responded correctly. Audience, you rock. I will turn it over to Jen to talk about must have records needed for computing income, gain and loss. Thanks Veronica. When calculating gain, loss or ordinary income relating to digital asset transaction you're going to need a minimum of five or six pieces of data.
The timestamp, which is when the transaction took place, the transaction type, or what happens in the transaction, was the asset bought, was it sold, was it sent, was it received, what happened? The asset description. What was it that was transacted was it Bitcoin or Ether or what was it? The number of units and the US dollar equivalent of the digital asset at the time of the transaction. Also, when you are calculating gain or loss you will need to know the adjusted basis of that asset that you're selling. And we are gonna explain all of these in more depth shortly. Now I will share some records that are more helpful to have. In addition to the must-have records that we just discussed, taxpayers will also want to have the following documentation to support their tax return reporting. Any related digital asset address or addresses in general.
In general these are the addresses that are used to send and receive digital assets in a transaction. Transaction hashes are unique identifiers that are associated with blockchain transactions. And keep in mind that not all sales of digital assets on custodial platforms will have a transaction hash or associated address. They sometimes, in the custodial exchanges, sometimes they use their own ledgers rather than paying the fees associated with reconciling the transaction with blockchain. Blockchain addresses are pseudo-anonymous, which means in general that just because you have it, have documented that as an address, that does not tell you who the person or the entity that controls that address is.
Which means that in addition to the blockchain address you have a counterparty in the transaction and the counterparty in that transaction would be the person or entity that your client is transacting digital assets with. You also want to document who the transaction is with, who is that counterparty. At tax time or during an audit it might be difficult to remember who digital assets were sent to you or received from, you know, prior to, like two or three years ago. So it's pretty important and it would most likely make those processes easier for the audit or tax preparation if that information was recorded at the time of the transaction.
For the same reason, contemporaneous documentation of the nature or purpose of the transaction will also be helpful in supporting the tax treatment of that transaction. If the taxpayers receiving digital assets or using digital assets as part of the trade or business, you will want to be sure to keep good records to support the tax treatment of those transactions as well as any expenses the same way you would any normal business with cash expenses. Let's move on to how to read an exchange statement. Here is a simplified example of some records the client may provide you in regard to digital asset activity at a centralized exchange. We have circled the key fields referenced in the previous slides.
We have got the timestamp field or when the transaction took place, and that might be reported in the customers local time or it could be in the time zone that the exchange itself is located or could be in UTC time. So that's not always consistent from exchange to exchange as to when the time it is being recorded as. Next you see the transaction type. Common transaction types that you might find an exchange records include buy, sell, send, receive, sometimes convert, reward, award or others. Most exchanges will publish user guides on their website that explain what these terms mean. So that's a good place to reference if you are unsure. Because the exchanges are not consistent from exchange to exchange.
Two of the transaction types that are unique to digital assets are the send and receive transactions. Generally speaking, you can't send traditional equities from one broker to another broker without transferring all of the assets in your account. The send means that the client sent the digital asset off the platform and the receive means the client receive digital assets from a source outside the platform. Additional analysis is required to determine whether those represent taxable sales and receipts or nontaxable transactions. And you will have more on that later. The currency or it could be called symbol or asset field will describe the digital asset used in that transaction and also note that the symbol used to describe digital assets might again not be consistent across exchanges or platforms.
So for example Bitcoin may be referred to as Bitcoin or it could be BTC or XBT or BITC or something else depending on the platform same as the transaction type, refer to the platform's website for additional clarity as needed. The units or amount field is pretty self-explanatory, it's he number of units being transacted the one thing to note though is that customers can buy and sell fractions of digital assets. So for example you don't have to buy an entire Bitcoin when making a purchase like you would with a share of stock. You could buy .00001 of a Bitcoin or even smaller than that.
Many exchanges and platforms charge fees for buying and selling digital assets so you want to make sure to consider the impact fees have on the purchase price or sales price of the digital asset. And Veronica looks like I think it is time for third polling question. Jen, yes it is, okay audience is time for a polling question. Records you must have for computing income gain and loss are A, timestamp and transaction type, B, asset description and number of units, C, US dollar equivalent at the time of the transaction and adjusted basis of the assets sold, or D, lastly all of the above, take a moment and click the radio button that best answers the question. I will give you a few more seconds to make your selection.
So just think about that. Okay. We are going to stop the polling now. And let's share the correct answer on the next slide. And drumroll, the correct answer is D, all of the above. And I see that 98% of you responded correctly. Audience, you're right on task. Jen, back to you to talk about capital gain or loss amount realized. Thanks Veronica. Here is a simple fact pattern that we will use to illustrate how to use exchange records to determine the amount realized in a digital asset transaction. On April 15, the taxpayer purchased one Bitcoin for $20,000 in cash. The taxpayer purchased a second lot of one Bitcoin on June 15 for $18,000. The taxpayer then sold 1.5 Bitcoin for $32,000 in August 2022.
So for purposes of determining the amount realized from the sale of Bitcoin we look to see what the taxpayer received from the sale of that Bitcoin. And in this fact pattern the taxpayer received $32,000. So that amount represents the amount realized. That's the easy part. Now let's look at the adjusted basis calculation. This client's total basis in the two Bitcoins immediately prior to the sale of the 1.5 Bitcoins is equal to $38,000. $20,000 from the 4/15 purchase and $18,000 from the 6/15 purchase. Please note that we are ignoring fees in these examples. We are trying to keep it simple.
Because the client is not disposing of his entire holdings in Bitcoin at this exchange we have to allocate basis to the Bitcoin sold for the purpose of calculating that gain or loss. Notice 2014-21 and the related FAQs that are posted on IRS.gov, as stated earlier, detail that taxpayers may specifically identify tax lots sold when calculating gain or loss. However, please be aware that in order to do so a client must have complete and accurate records for all digital assets purchased essentially since inception. Absent complete and accurate records the client may not use specific identification because without records they will not be able to specifically identify sold lots. So, the default cost flow methodology is first-in-first-out or FIFO such that the taxpayers are deemed to have sold the oldest lots first. Let's continue with the adjusted basis.
Let's assume here the client uses the FIFO methodology. This means the sale will be treated as selling the entire one Bitcoin of the amount purchased on 4/15 for $20,000 and half of the one Bitcoin purchased on 6/15 for $18,000. Half of the $18,000 is $9,000. Therefore the client's basis in the 1.5 Bitcoin sold in August is equal to the $20,000 from the first purchased Bitcoin and the $9,000 allocated from half of the second purchased one Bitcoin, which in total would be $29,000.
Moving on to the capital gain. This slide summarizes the key pieces of information in this simple example. We determined the amount realized on the earlier slide to be $32,000 of cash. We calculated the adjusted basis on the previous slide, which is $29,000 and the difference between $32,000 of the amount realized and the $29,000 of basis is equal to a $3,000 gain. And that gain is short-term because the holding period of the Bitcoin is less than one year. Now I'm gonna cover documenting basis in digital assets.
The example that we just covered is relatively straightforward because it only involved a few digital asset transactions, 2 buys one sell but in reality it usually is much more complex than that and it's especially true if the taxpayer has multiple accounts at different exchanges or if they have a high volume of transactions and it gets even more complicated if the taxpayer custodies their own assets using self hosted wallets or has transactions in the defi eco system or NFTs. So it's critical that they maintain good records. So when you think about the transaction just covered you have the amount realized and you have adjusted basis.
Generally the amount realized is easy to calculate even after the fact. Adjusted basis is much more difficult and this is because you can't tell on based on public price information what the taxpayer's bases was at the time of the sale likewise under the current reporting regime most centralized exchanges won't know what the basis was either, so all that needs to become calculated and tracked by the taxpayer and this is why it's critical to maintain records to support those basis calculations. The types of records that would be used by the taxpayer would depend on the digital asset activity. For example let's say they used a centralized exchange to buy and sell. Most exchanges will have an option for the taxpayer to download their transaction into a CSV or Excel file.
However, the information that these records would still be missing, like I mentioned earlier, is who the counterparty in the transactions are. So that would still need to be noted even if the transactions were downloadable from the centralized exchange. If the taxpayer self custodies their assets in un-hosted wallets they have to garner their own transaction history either from the public blockchain or their own software. Continuing with documenting basis. If the taxpayer engages in staking, mining or similar activities the taxpayer should keep all records associated with that activity. If the taxpayer is in a trade or business with these activities they should also keep records of any ordinary and necessary business expenses associated with that activity.
Some clients may use debit cards linked to digital asset accounts so they can use digital assets to make purchases. The use of digital assets to purchase goods or services represents taxable sale of the digital assets so the taxpayer will want to keep records of those purchases as well. Let's discuss an unknown receipt of a digital asset. In our next example you will see some familiar headings.
The date, the transaction type, the amount, which is .5 Bitcoin and the dollar value $10,000. This time though we also see a transaction hash, the transaction hash indicates that this transaction was recorded on a blockchain or on chain. Note that you might not always see a transaction hash in centralized exchange records like I mentioned earlier and this is because many transactions at the exchange when you buy and sell that counterparty is that exchange so you aren't actually transacting on the blockchain. So here seeing the transaction hash we know that the transaction hash is actually recorded in public blockchain.
Based on this information we can determine that they received .5 Bitcoin for $10,000 on June 12, 2022. So, that's a good start for determining the tax impact of that transaction but we need to supplement that with questions to the taxpayer. First, who is the Bitcoin coming from, is it a counterparty or is it another wallet they control or is it somebody else giving a gift or is it for services and then we need to ask why they received the Bitcoin. And the answer to those questions will drive that tax treatment for that transaction.
Let's cover the wages for services as an example. So say you have that conversation with the taxpayer and you determined that the client performed services for his employer and he received .5 Bitcoin from his employer at the time that amount is shown as received here in the records. Let's say you get additional information or records from the taxpayer that indicates they sold that Bitcoin a few months later for $12,000 as you can see here. So, how should they report these transactions on their tax return? Remember you have two transactions, the receipt of the Bitcoin for performing services and the sale a few months later. Moving on to the analysis of the facts. First let's look at the wages.
The client must include the fair market value of the .5 Bitcoin at the time of receipt, $10,000, in wages on his 1040 line 1a in the year he received it. The employer should report this to the employee on Form W-2. Once he has reported the receipt of digital assets as wages he now has the basis for the digital assets that he is now holding as a capital asset. Now you have the second transaction, the sale of the .5 Bitcoin for $12,000. So the amount realized is that $12,000 of the sale and the basis is the $10,000 that was established when it was included in wages. The date of the sale shows it was held less than a year.
Again the fair market value establishes the basis as I said is what was recognized as wages which is $10,000 and the sale was for $12,000 the fair market value at the time of the disposition. The client recognizes a short-term capital gain of $2,000, $12,000-$10,000, when he sells the .5 Bitcoin for cash. Keep in mind for simplicity we are leaving out any transaction fees that may have occurred and also please don't get hung up on the withholding amount. We are trying to keep this very simple for demonstration purposes. Veronica, I see it is time for our fourth and final polling question.
Why yes it is, audience time for the fourth and final polling question. Example of records needed to document basis and digital assets include, A, all records associated with staking, mining and validating and similar activities, B, internal records for any transfers to from and between accounts, C, both A and B, and D, none of the above, take a moment to click the radio button next to your election. I will give you a few moments to make your selection. Okay we are going to stop the polling now and let's share the correct answer on the next slide. The correct response is C, both a and B. So let's take a look and see how everybody did. I see 94% of you responded correctly. Good job. Back to you, Jen, to talk about reporting wages.
Thanks Veronica. So referring to the two transactions we went over before the poll question just to recap we have the $10,000 that was reported as wages and became the basis for the asset, then we have the sale of that asset for $12,000 two months later. Let's look at where we would be reporting these transactions. Wages would land on line 1a of 1040 where all of the W-2 wages are included and you can also see the Yes box on the digital assets question is checked because not only did the taxpayer here receive digital assets for services, but they also have the disposition of those assets in the same year.
Again, don't get caught up on how much the employer paid for withholding and where that is falling and such, like I said earlier we are trying to keep it simple. Now I'm gonna cover reporting capital gains. The second part of this transaction was the sale of the Bitcoin for cash, and like any other piece of property, that would be reported on Form 8949 with all the applicable information filled out. So as you can see here since this is a short-term capital gain it's getting on Part one, line 1. It will include the description, the acquisition date, again that is when the taxpayer received the Bitcoin for performing services, the date of sale, the proceeds that they received, the basis and ultimately that $2,000 capital gain.
So, if you notice here we left off one important piece of information and that is in Part one above. Generally speaking you need to check box A, B or C on the form. In most cases these transactions are not reported on the Form 1099-B so depending on the fact pattern of the case and assuming it was not reported on the 1099-B you would mark box C. Let's look at self-employed income from services. So let's take that same example but twist the facts a little bit. Instead of a client performing services for the employer, let's say the client is a self-employed attorney and that for the sake of simplicity is operating a sole proprietorship and reports all their activity on Schedule C. So again, the attorney has performed services and received .5 Bitcoin for providing those services worth $10,000 at the time of receipt.
Then they sell it two months later for $12,000 like the prior example. Continuing with self-employed income from services. So instead of reporting the income as wages on Line 1a of the 1040, rather the attorney would report that income as gross income on Schedule C. And like in the prior example when the attorney sells that Bitcoin two months later they are gonna have the same short-term capital gain. And again you notice the footnote, no transaction fees for the sake of simplicity. Let's cover reporting that income on Schedule C. Again fairly self-explanatory here. An attorney performing services and getting paid for those services as a sole proprietorship. We need to report those as gross receipts on Schedule C. And the attorney like in the prior example would need to mark Yes on that digital asset question on the face of the 1040.
Because they received and sold digital assets during the year. Now, I will talk about ordinary income - staking rewards. Now we are going to switch topics a little bit to staking rewards. The next example involves the taxpayer staking or depositing a token in a reward program offered by a centralized exchange. When you look at the exchange statement you can see the multiple entries that say rewards. You'd have to ask the client what these transactions represent but most likely this will represent ordinary income for the client at the time of receipt or when the taxpayer has dominion and control over those rewards.
Again this might represent staking income through a centralized exchange or some kind of reward program offered by the exchange. As you can see here the client received these rewards over a period of time you can see the first Bitcoin was received on April 23 for a total of $25 and then subsequently they received amounts at three other times for a total of $112 of rewards. Now we need to figure out the proper tax treatment of these rewards. It will depend on the facts and circumstances but generally speaking with property transactions if they are receiving rewards for doing something that's going to generally be ordinary income to the taxpayer. Again we are just using simple fact patterns to illustrate the tax impact of certain digital asset transactions. The transactions we've analyzed here have taken place in a centralized exchange.
Many taxpayers instead will interact with decentralized protocols and services through self-hosted wallets. That's beyond the scope of our discussion here today but please be aware that this activity does occur and the tax reporting can become much more complex. Moving on to reporting ordinary income on Schedule 1. Here you can see where the staking rewards would be reported on the 1040 given that fact pattern presented, the $112 which was the fair market value at the time of receipt will be reported on Schedule 1, Other Income. So let's cover the sale of staking rewards.
Now that they have picked up that amount in income the taxpayer comes back an says oh, I forgot to mention I sold those rewards on December 25 of that year for $85. So, let's look back at the activity on this account. You can see the staking rewards for April and they totaled $112. The taxpayer recognizes this as ordinary income and it became the taxpayer's basis in the digital assets received. On December 25, the taxpayer sells the digital assets for $85 which is the amount realized. The taxpayer has a capital loss of $27, which is equal to the difference between the amount realized of $85 less the taxpayer's basis of $112.
That's all I have. So I'm going to turn it back over to you, Veronica. Okay sounds good thanks so much, Jen. Okay audience hello again it's me Veronica Tubman and I will be moderating the Q&A session. But before we start the Q&A session I want to thank everyone for attending today's presentation, Taxable Transactions with Digital Assets. Earlier I mentioned we want to know what questions you have for our presenters. So here's your opportunity. If you have not input your questions there is still time.
Go ahead and click on the drop-down arrow next to the ask a question field, type in your questions and click send. Jen is staying on with us to answer some questions but one thing before we start. We may not have enough time to answer all the questions submitted, but we will answer as many questions as time allows. So let's get started so that we can answer as many questions as possible. Okay let's take a look. Jen, is there a de minimis sale of virtual currency that does not need to be reported such as a $23 purchase of goods?
If so, what is that amount. So no, there is currently no de minimis exception regarding a sale or use of digital assets. So, if you buy that cup of coffee with some Bitcoin you have a taxable transaction. Even if that coffee is just counted to a $1.00 you are still going to have that taxable transaction. Okay. That's good to know. Okay let's see. Audience you guys you've got some really great questions. So, let's see if the taxpayer cannot document basis does the service take the position that the fair market value is zero, Jen? Generally if the taxpayer can't provide anything to substantiate the amount paid for the asset then yes the position the service would generally take is that of zero basis.
Okay got it. Let's see okay here's another good question; What is the difference between coins and tokens? Generally there's no difference between coins and tokens for federal income tax purposes. So that's not something when preparing your tax return or when a tax return preparer is preparing someone else's return. It is not something they would have to worry about for tax purposes they are going to be treated the same. Okay. Let' see.
Okay. Jen, what is the difference between Bitcoin and Ethereum, I thought they both are virtual currency. Can you give us a little help on the difference, please. Yeah, no problem. They are both virtual currencies or digital assets. However, crypto currencies depending on what terminology you are wanting to use, however, the software code is different and they have different functionalities and use cases.
There's thousands of different, tens of thousands, tons of different crypto currencies out there and Bitcoin and Ether, Ethereum, blockchains are two different types, two different software codes. Okay, so we just need to be on the lookout for the difference in the software code. Thanks for that. Okay, let's take another look. Okay, Here's another good one. Is a taxpayer getting taxed twice if A, they receive a virtual currency as payment for services and that is for Form W-2 or Form 1099, and then B, when they sell it as a capital asset at a gain? So, can you help us out with that one? Yes, of course. No, the taxpayer will receive basis in the amount reported as income, that is taxed as income, and then that basis is used to calculate the taxable gain or loss.
So, the difference between what they sell it for and what they have as basis and that is what the second amount is going to be, so they are not being taxed on that original amount, they are being taxed on the difference between what that basis and the original amount is and what they sold it for or what they realized when they disposed of it. Okay that is good to know. Okay this is the final question. Hello, you've mentioned that these transactions are taxable in the normal course of business.
But aren't the transactions taxable if a person is paying for a good or service for personal purposes as well? For example, paying for sports event with Bitcoin? And that is a big thank you for giving some clarity on that, Jen. Yeah. No problem, yes disposing of a digital asset to pay for goods or services would be a taxable disposition of the digital asset.
So whatever you paid for, if you dispose of that digital asset when you paid for it, you would have a taxable transaction. Okay much appreciated, Jen. Okay let's see. Well, audience that is all the time we have now for your questions, but I want to thank our presenter for sharing her knowledge and experience and for answering your questions. But before we close the Q&A session, Jen, can you share some key points you want the attendees to remember from today's webinar?
Yeah, I do have some key points from today's presentation. Digital assets are any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the secretary. You guys will remember that was the definition that was in the Infrastructure Investment and Jobs Act of November 2021. Federal income tax principles that are applicable to property transactions drive the tax treatment of digital assets.
Just to reiterate, since this is a key point, digital assets are considered property. There's ordinary income recognition if digital assets are received as payment for goods or services in the normal course of business and then continuing with the key points, we have got income recognition that generally forms the basis of the digital asset that's received. The fair market value of digital assets are measured in US dollars at the time of receipt and receipt occurs when the recipient first has dominion and control of that asset.
So continuing with the key points, we have some common digital asset recognition events and those include the sale of digital assets for cash, for other property including other digital assets, the use of digital assets to pay for goods and services, receipt of digital assets as payments for goods and services and lastly, remember, records, records and more records; documentation of basis is critical and it will save some really, really big headaches in the long run.
And that's all the key points that I have. I will turn it back over to you, Veronica. Okay, thanks again, Jen, we appreciate you. Audience we are planning additional webinars throughout the year so to register for an upcoming webinar please visit IRS.gov keyword search webinars and select the Webinars for Tax Practitioners or Webinars for Small Businesses. And when appropriate, we will be offering credits and CE credit for upcoming webinars. We invite you to visit our video portal [not available] at www.IRSvideos.gov [not available]. There you can view archived versions of our webinars. But again, continuing education credits or certificates of completion are not offered if you view an archived version of any of our webinars on the IRS Video Portal [not available].
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