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How Do I Answer the Crypto Tax Question on Form 1040?

How Do I Answer the Crypto Tax Question on Form 1040?

In years past, Form 1040 contained a question that directly asked taxpayers about their cryptocurrency activity. 

This year, the wording of the cryptocurrency question has changed. For the 2021 tax year, not every cryptocurrency investor will be required to answer ‘Yes’. 

In this guide, we’ll break down everything you need to know about the cryptocurrency question on Form 1040. We’ll break down when investors need to answer ‘Yes’, explore the potential tax ramifications of answering the question, and discuss the next steps you should take when it comes to filing your taxes. 

The crypto question for 2021 vs. 2020 

In previous years, the Form 1040 question asked taxpayers if they had ‘acquired’ cryptocurrency. Many investors weren’t sure if they needed to check ‘Yes’ if they had held crypto for the year without disposing of it. 

The IRS has tweaked the language of the question and released new guidance to clear up this confusion. The proposed new language of the question is: “At any time during 2021, did you receive, sell, send, exchange, or otherwise dispose of any financial interest in any virtual currency?”

Now, investors who only purchased or held cryptocurrency during the 2021 tax year do not have to answer ‘Yes’ to the Form 1040 question.  

Form 1040 cryptocurrency tax question

When must you answer ‘Yes’ to the 1040 virtual currency question?

You must answer yes to the virtual currency question if you did one or more of the following transactions in 2021: 

  • Received crypto for free or for payment for goods or services provided 
  • Received crypto from an airdrop, hard fork, mining or staking
  • Sold crypto for fiat currency (like USD)
  • Exchanged one crypto for another
  • Exchanged cryptocurrency for property, goods or services
  • Disposed of a financial interest in a cryptocurrency

Keep in mind, just because you select ‘yes’ to the virtual currency tax question, does not necessarily mean you owe taxes on your crypto. For a complete breakdown of how cryptocurrency taxes work and when you do or do not owe taxes, check out our Complete Crypto Tax Guide.

When can you answer ‘No’ to the 1040 virtual currency question?

The new 1040 instructions also clarified that you do not need to check ‘yes’ to the virtual currency question if in 2021 you only:

  • purchased cryptocurrency
  • held cryptocurrency in wallets or accounts
  • transferred crypto between self-owned or self-controlled wallets or accounts

In other words, if you simply held your cryptocurrency and did not make any sales or earn any crypto income, you do not need to answer ‘yes’ to the Form 1040 question. 

Why does the IRS ask if you own crypto? 

Some investors feel nervous about answering ‘Yes’ to the 1040 question because they are afraid that it may increase the likelihood of a tax audit

It’s likely that these fears are unfounded. At this time, tax experts say that the IRS is asking this question to better understand how many Americans are actively transacting in cryptocurrency. There’s no evidence that answering ‘Yes’ could potentially lead to an audit. 

On the other hand, answering ‘No’ to the question when the taxpayer has relevant crypto transactions for the year could be considered tax fraud and lead to criminal penalties. 

What are the next steps after answering ‘Yes’ to the Form 1040 question? 

If you answer ‘Yes’ to the Form 1040 question, you will need to report all your crypto disposals and income events on your tax return. 

Typically, cryptocurrency disposals need to be reported on Form 8949. Income events are reported on Schedule 1, Schedule B, or Schedule C depending on the specific nature of the transaction. 

For more information, check out our guide to reporting cryptocurrency on your taxes

The IRS is cracking down on crypto tax compliance

The cryptocurrency question on Form 1040 highlights a simple truth: the federal government is paying closer attention to the crypto ecosystem than ever before. 

Here’s a list of noteworthy events that took place during the 2021 tax year. 

April 2021: The IRS files John Doe Summons targeting the crypto firms Kraken and Circle. 

May 2021: The Department of the Treasury released a report that called for additional resources to the IRS for increased crypto tax enforcement. 

November 2021: President Biden signed the infrastructure bill, which will put into place stricter tax reporting rules for brokers that facilitate crypto transactions. 

It’s clear that now more than ever, it’s crucial for investors to accurately report their crypto taxes. 

File your crypto taxes today! 

Crypto tax software like CoinLedger can make filing your taxes easier than ever. 

With CoinLedger, you can automatically pull in transactions from exchanges like Coinbase, Kraken, and Gemini in minutes. Once you’re done uploading your transactions, you can generate a free tax report with the click of a button. 

Get started with a free preview tax report today

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