By Tom Taulli

Bitcoin has been on a tear this year, notching an impressive 151% gain and keeping crypto investors glued to their screens. Over the past couple of weeks, the world's largest cryptocurrency has been flirting with the $100,000 mark. But Bitcoin isn't the only star of the show. Ethereum, Solana, and even the meme-fueled Dogecoin have delivered strong returns.

Then there's the ripple effect on stocks tied to the crypto ecosystem. MicroStrategy, Coinbase, and Robinhood have all seen significant surges, not to mention the crypto ETFs. The risks of this asset category are hard to ignore. It is famously volatile, as demonstrated by the bruising bear markets of 2018 and 2022 that left many investors reeling.

Given this backdrop, financial advisors may want to recommend that clients consider taking some profits off the table. However, such moves come with important tax implications that require careful planning.

The Rules. The Internal Revenue Service treats virtual currencies as property for federal tax purposes. This means transactions involving crypto are subject to the same tax rules as real estate or stocks. Whether you're buying, selling, or exchanging, the same principles apply.

Let's consider an example. Suppose you have a client, Jane, who is active with crypto. This year, she sold some Bitcoin at a profit, used Ethereum to purchase a new laptop, exchanged Litecoin for Dogecoin, and received Bitcoin as payment for her services.

These are the tax implications:

   -- Selling Bitcoin: When Jane sold her Bitcoin, she realized a capital 
      gain. 
 
   -- Buying a laptop with Ethereum: Paying for the laptop with Ethereum is 
      treated as a sale of the cryptocurrency. The taxable gain or loss is the 
      difference between Ethereum's fair market value (FMV) at the time of 
      purchase and her original cost basis in it. 
 
   -- Exchanging Litecoin for Dogecoin: Swapping Litecoin for Dogecoin is 
      another taxable event. Jane's gain or loss is calculated as the 
      difference between the fair market value of the Dogecoin she received and 
      her adjusted basis in the Litecoin she traded. 
 
   -- Accepting Bitcoin for her design work: That money is taxed as ordinary 
      income. The value is determined by the Bitcoin's fair market value on the 
      day she received it. "If you are paid as an employee, the crypto will be 
      included in your W-2 based on the FMV at the time you received it," said 
      Lisa Greene-Lewis, who is a CPA and tax expert for TurboTax. "If you are 
      paid as a contractor or freelancer, the FMV of the crypto you received 
      will be reported on Form 1099-NEC by the payer if the value is $600 or 
      more." 

Strategies to Reduce Taxes. There are various approaches advisors and their clients can use to minimize taxes. Here are a few to consider as year-end approaches:

   -- Only sell those assets held for over a year. Long-term gains qualify for 
      more favorable capital-gains tax rates than short-term holdings. 
 
   -- Try tax-loss harvesting. Here, you can sell underperforming crypto assets 
      at a loss, then use that loss to offset gains from other investments. 
      Here's the kicker: the wash-sale rule doesn't apply to cryptocurrencies. 
      This means your client can sell a crypto asset at a loss and repurchase 
      it right away -- no need to wait 30 days. 
 
   -- Move crypto assets into a self-directed individual retirement account 
      (IRA). Gains can grow tax-deferred, and if you opt for a Roth IRA, 
      qualified withdrawals are entirely tax-free. Plus, Roth IRAs come with 
      the added benefit of no required minimum distributions (RMDs). 
 
   -- Donate crypto to qualified charitable organizations. If your client has 
      held the asset for more than a year, this approach offers a double 
      benefit: they can avoid paying capital-gains tax on the asset's 
      appreciation and claim a charitable deduction for its fair market value, 
      up to 30% of their adjusted gross income. 

The challenge, however, is that many nonprofits aren't equipped to accept crypto donations. That's where donor-advised funds (DAFs) come in.

"When you contribute money to a DAF, you get the charitable deduction on your income taxes and then the money is invested, tax-free, in any portfolio the DAF offers," said Adam Nash, who is the co-founder and CEO of Daffy, a fund that does accept crypto. "When you want the money to go to a charity, you just tell the DAF and they get the money to the charity."

Forms to file. Currently, reporting cryptocurrency transactions to the IRS largely depends on Form 1099-K filings from platforms like Coinbase and PayPal, along with taxpayers' self-reporting. But starting in 2025, brokers and financial intermediaries will be required to report crypto sales on behalf of their clients using Form 1099-DA.

"The use of cryptocurrency triggers the reporting requirement, whether sold for cash or exchanged for other digital assets, property, or services," explains Mark Parthemer, Florida regional director and chief wealth strategist at Glenmede.

By 2026, the IRS will take this a step further, mandating that the cost basis (the initial purchase value) be included on the Form 1099-DA in addition to the sale price.

"This will help taxpayers track their transactions and calculate gains or losses more accurately," said Ronen Cojocaru, the CEO of digital asset trading platform 8081.io.

"It's part of a broader effort to reduce underreporting of cryptocurrency income and improve transparency. If you're trading or investing in crypto, expect to receive this form from your broker during tax season."

Tom Taulli ( @ttaulli ) is a freelance writer, author, and former broker. He is also the author of the book, Artificial Intelligence Basics: A Non-Technical Introduction .

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

December 02, 2024 16:18 ET (21:18 GMT)

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