Over the past few months, the IRS has been targeting crypto traders. Letters 6174-A, 6173, and CP2000 have been mailed to more than 10,000 individuals, and frantic cryptocurrency holders are unsure of the next move to make.

The problem is the IRS doesn’t have all of the information it needs. Now, the agency is blindly contacting crypto holders whether their taxes were filed correctly or not. The government is basing its findings on data collected from cryptocurrency exchanges like Coinbase, giving them an incomplete picture of the crypto world.

Crypto Is Property

In the United States and many other countries, cryptocurrency is taxed the same way as property, like stocks and bonds, not currency. And like property, capital gains and losses need to be reported on your tax return each year. This means that crypto traders must keep track of every time they buy, sell, or trade their currency. 

Unsurprisingly, many cryptocurrency holders haven’t reported their crypto activity, which is why the government is taking such a keen interest. However, the IRS requires traders to use Form 1099-K, which is used to report gross transactions on a third-party network like a cryptocurrency exchange.

The Problem With Form 1099-K

Form 1099-K gives the IRS an overview of a trader’s activity. It’s used to summarize each time a trader buys, sells, or transfers their cryptocurrency. If a cryptocurrency holder has more than $20,000 of activity, the crypto exchange will send this form to both the holder and the IRS. Seems like a good system, right? Actually, it’s extremely problematic. Remember, cryptocurrency is taxed like property, so the amount of transactions a crypto trader makes is irrelevant when it’s tax time. Instead, cryptocurrency holders need to report their capital gains or losses as this is the only thing a trader can be taxed on. 

Think of it this way. Say you have $5,000 worth of Bitcoin that you purchased in June. If you sell this a few months later for $3,000, you have a net loss of $2,000. But according to Form 1099-K, the government will see that you have $7,000 in gross cryptocurrency transactions. This says nothing about the capital loss you’re entitled to claim. On the other hand, if cryptocurrency users were issued Form 1099-B, which includes all of the trade information plus all of the data required to calculate and accurately report capital gains and losses, the government would have the information it needs to see the full picture.  

Why Form 1099-B Doesn’t Work 

Why don’t crypto traders receive a Form 1099-B instead of Form 1099-K? Because a cryptocurrency exchange can only see what you’re doing on its platform. If you use more than one exchange, it has no way of knowing where your crypto is, what you traded it for, or what the fair market value is. Because exchanges lack the necessary information to calculate your capital gains and losses, they can’t issue Form 1099-B.

The fact that the IRS is relying on misleading information is a problem for both the government and cryptocurrency holders. If you’re going to be taxed on capital gains and losses, not gross transaction amounts, a 1099-K doesn’t paint the complete picture. The good news is that if you’re a crypto holder who received a letter from the IRS, you don’t need to panic. If you’ve been filing your crypto taxes correctly, you should be fine. However, if you have questions or concerns, it’s advisable to contact a tax professional, like the team at CryptoTaxPrep.com. After all, it’s taking proactive steps to protect yourself is never a wrong move.

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