Reporting Virtual Currency Transactions

Several years ago, the IRS concluded that cryptocurrency, also called virtual or digital currency, is property not currency (Notice 2014-21). As such, you must report gain or loss on every transaction involving virtual currency. For Bitcoin and other virtual currency held for investment, transactions produce capital gain or loss. Where virtual currency is used to pay for services, the recipient reports ordinary income equal to the value of the virtual currency.

The IRS has begun to send letters to more than 10,000 taxpayers who have had virtual currency transactions reminding them to report the transactions now (IR-2019-132, 7/26/19). The IRS hasn’t divulged how it identified these taxpayers, but some undoubtedly resulted from a federal court order in March 2018 requiring Coinbase to provide data on about 13,000 accounts.

There are three letters being used for this purpose:

• Letter 6173 says the IRS believes the taxpayer has had virtual currency transactions but did not file a return in one or more years from 2013 through 2017. A taxpayer must respond to the letter even if he or she believes that there has been proper reporting. The failure to report virtual currency transactions can result not only in back taxes, interest, and penalties, but in some instances also criminal prosecution.
• Letter 6174 merely indicates that the IRS knows a taxpayer has one or more accounts with virtual currency and encourages  reporting of virtual currency transactions.
• Letter 6174-A is for a taxpayer where the IRS has reason to suspect that there has been a failure to report virtual currency transactions.

Whichever letter is received, as well as for taxpayers who have not received a letter, it is advisable to file amended returns including any omitted virtual currency transactions.

While virtual currency transactions must be reported for income tax purposes, virtual currency itself does not have to be reported for FBAR purposes on the annual FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FinCEN regulations at 31CFR §1010.350(c)). However, this status for virtual currency could change in the future.