What Is Virtual Currency?
Virtual currency is not real currency issued by a government (“fiat money”). Instead, it is issued and usually controlled by its developers, and may be used for payment among members of a particular virtual community. The IRS is interested only in virtual currency that is convertible into real money or that can act as a substitute for real money. The best-known form of convertible virtual currency is cryptocurrency. Cryptocurrency uses cryptography to secure transactions, which makes it impossible to counterfeit or double-spend. Cryptocurrencies don’t have a central issuing or regulating authority—they use a decentralized system to record transactions and issue new units. Bitcoin is the most widely used form of cryptocurrency, but there are dozens of others, including Ethereum, Litecoin, Dogecoin, Tether, and Binance Coin. Cryptocurrencies other than bitcoins are also called “altcoins.” As we explained in a previous article,2 for tax purposes virtual currency is property, not money. For tax code purposes, you treat it much the same as gold or a share of stock.
What If You Answered Wrong?
It’s highly likely that many taxpayers answered the Form 1040 crypto question wrong. For example, it’s probable that many people who purchased bitcoins and held on to them the whole year answered “yes.” If you answered wrong, do you have to amend your return? It depends. You answered “yes” when you should have answered “no.” If you answered “yes” to the crypto question when you should have answered “no,” then you don’t have to do anything. There is no need to amend your tax return. The IRS is only interested in information about taxable crypto transactions. You answered “no” when you should have answered “yes.” If instead you answered “no” when it should have been “yes,” and you did not report your taxable virtual currency transactions, you need to file an amended return. (If the due date for your return has not passed, you can file a superseding return instead.)
If you fail to do so, you may get a letter from the IRS advising you to file an amended return and pay any taxes due. The IRS began sending out such letters in 2019.