2020 Form 1040 Instructions Updated for CAA 2021 - Virtual Currency

The IRS has released a new draft of the instructions for Form 1040 and Form 1040-SR, U.S. Tax Return for Seniors, that incorporates recently legislative changes made by the Consolidated Appropriations Act, 2021 (CAA, 2021, PL 116-260). The draft instructions also contain other new information including information about virtual currency reporting.

IRS released a previous draft of the instructions to Form 1040 and Form 1040-SR in October 2020. 

In 2019, the IRS added the question, "At any time during [the tax year], did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?" to the Form 1040.

In the October 2020 draft instructions, the IRS said that a transaction involving virtual currency does not include the holding of virtual currency in "a wallet or account," or the transfer of virtual currency from one wallet or account the taxpayer owns or controls to another that the taxpayer owns or controls.

The October 2020 draft instructions also noted that, "A transaction involving virtual currency includes:

• The receipt or transfer of virtual currency for free (without providing any consideration), including from an airdrop or following a hard fork;
• An exchange of virtual currency for goods or services;
• A sale of virtual currency; and
• An exchange of virtual currency for other property, including for another virtual currency."

The new draft instructions point out that, “Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency ("real currency"), that functions as a unit of account, a store of value, or a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency.”

The instructions then say that, “The IRS uses the term 'virtual currency' to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.”  

This definition of virtual currency (including the statement that regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes) matches the definition that the IRS uses in its FAQs regarding virtual currency transactions. 

The new draft instructions also revise the list of what transactions include, providing that "A transaction involving virtual currency includes, but is not limited to  (revisions in italic):

• The receipt or transfer of virtual currency for free (without providing any consideration), including from an airdrop or following a hard fork;
• An exchange of virtual currency for goods or services;
• A purchase or sale of virtual currency;
• An exchange of virtual currency for other property, including for another virtual currency; and
• An acquisition or disposition of a financial interest in virtual currency."

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