Cryptocurrency has become extremely popular, but the rules surrounding its taxation aren’t often discussed. That’s led to the spread of some dangerous misconceptions that could land cryptocurrency holders in some serious trouble with the IRS.

Failure to correctly report your cryptocurrency transactions and fix prior mistakes could even result in criminal prosecution. To help clear up some of the confusion and ensure that you don’t fall for any of the more costly tax myths, we’ve debunked some of the most popular ones below.

1. Crypto Compensation isn’t Taxable

If you receive payment for your goods or services in the form of cryptocurrency, the IRS considers it income equivalent to cash compensation, whether you’re operating as an employee or an independent contractor.

As a result, the standard income tax rules apply, and you’ll have to include the Fair Market Value (FMV) of the cryptocurrency on the date you received it in your gross income.

Additionally, a capital gain tax will be triggered when you convert the cryptocurrency into your country’s fiat currency. If you do that right away, you may be able to keep that tax to a minimum since the asset won’t have much time to gain value.

If you hold onto it long enough for the price to go up, you could face an even larger tax bill when you go to sell.

2. Mined Cryptocurrency isn’t Taxable

Mining is the process through which individuals (or mining groups) audit previous cryptocurrency transactions, confirm that there has been no double-counting, and update the blockchain public ledger.

Miners are sometimes rewarded for their efforts and receive new units of cryptocurrency (if they’re lucky). Mining adds new cryptocurrency into circulation, generating the units independently of an employer.

Because miners don’t think of the units as compensation, it’s easy to think that the units don’t count as taxable income.

Unfortunately for them, that’s not the case. Again, cryptocurrency is considered property by the IRS, and the receipt of any property is a taxable event, even if it’s not received from an employer.

Actually, the rules for mined cryptocurrency are very similar to the rules for found property: If you were to dig up a valuable diamond necklace that was buried in your backyard, the IRS would require that you declare the FMV of the necklace as income, even if you didn’t sell it.

Mining cryptocurrency works the same way. You’re essentially “finding” new cryptocurrency, so you need to declare its FMV as income to the IRS and pay the appropriate taxes.

3. Hard Forks and Airdrops aren’t Taxed

At this point, you can probably guess where this is going. There’s no such thing as free money when it comes to the IRS, and they’ve made absolutely sure that this applies to cryptocurrency (even though it’s technically not money).

A hard fork is when a cryptocurrency splits in two because of a change in the blockchain’s software. The update creates a new form of cryptocurrency that diverges from the previous one.

This can sometimes lead to holders of the original cryptocurrency to receive additional units of the new one in the form of an airdrop.

In 2019, the IRS issued guidance stating that airdropped units are to be included in a taxpayer’s gross income at their FMV.

It can be difficult to calculate the FMV of the new units if they’re not yet being actively traded, so some further guidance may need to be issued in the future.

4. The $10,000 “Personal Use” Exemption

There’s a common misconception floating around that individuals can claim an exemption for cryptocurrencies up to $10,000.

Were this the case, any cryptocurrency asset under the limit would be tax-free, and you’d only have to pay taxes on asset transactions that exceed the limit. This is false and could cause you to significantly under-report your income if you believe it.

The myth most likely stems from the personal use exemption that can be found in Australia, which states that “Personal use assets are exempt from capital gains taxes if they’re acquired for less than $10,000.”

In Australia, a personal use asset is one that is “used or kept mainly for personal use or enjoyment.” This would only apply to cryptocurrency if it was bought for personal spending (not investment purposes) and then sold very quickly. In the United States, the exemption doesn’t exist at all.

5. Paying with Cryptocurrency isn’t Taxable

Many people fail to realize that when you use your cryptocurrency to pay someone else, it’s still a taxable event on your end as much as the recipient’s because of the cryptocurrency’s status as property and not a fiat currency.

Even though you aren’t necessarily converting the asset into cash before you use it to purchase something, you’ve still “sold” an asset in the eyes of the IRS when you dispose of it.

And whenever you sell property, you trigger the capital gain taxation rules. You’ll have to pay taxes on any difference between your basis and FMV on the date of sale, which might be pretty large given how volatile cryptocurrencies can be.

6. Trades of Cryptocurrency aren’t Taxable

Similar confusion often arises when individuals trade their cryptocurrency and receive another cryptocurrency in return.

One reason that individuals make so many mistakes in these transactions is because of the like-kind exchange rule in the IRS Code Section 1031. The section allows you to defer taxes on sales of your property indefinitely, as long as you use your sale proceeds or trade directly for another property of the same kind.

There was some debate previously as to whether cryptocurrency could qualify for the treatment until the Tax Cut and Jobs Act (TCJA) disbarred any property except real estate from qualifying.

With the new rules, it’s been confirmed that cryptocurrencies do not qualify for like-kind treatment. So trading units of one cryptocurrency for units of another is the same as using it to purchase goods or services for tax purposes.

7. Crypto Scams are Tax Deductible

Lastly, we have one more mistaken idea stemming from some outdated rules. 

The IRS allows a tax deduction for individuals with “theft losses.” They define theft as “the taking or removal of property with the intent to deprive the owner of it,” and allow a deduction equivalent to the FMV of the lost property.

Scams and fraud surrounding cryptocurrencies are quite common, and since cryptocurrencies are considered property, the loss of those units to scammers should theoretically qualify for theft loss deductions. 

However, again as a result of the TCJA, you can only deduct theft losses attributed to a federally declared disaster (at least from January 1, 2018, to December 31, 2025).

Sadly, for those taken advantage of by scammers, your personal losses of cryptocurrency units are very unlikely to ever meet that requirement.

Key Takeaways

The most important takeaways should be to always treat your cryptocurrencies as property and to assume that the IRS will tax you on them more often than not.

But even if you feel like you’ve got a good handle on the basics, consult with a professional before you make any big decisions that may impact your taxes.

If you’re currently holding cryptocurrencies and are looking for further guidance on your tax planning, Founders CPA can help. Check out our free consultation so we can optimize your cryptocurrency strategies today.

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