The fair market value of a cryptocurrency is a crucial piece of information for tax preparation. It's the cornerstone of how the IRS views cryptocurrency transactions and, therefore, how they should be reported on tax returns.
In its infinite wisdom, the IRS has decreed that crypto is property, and as such, it's subject to the same tax rules as other property. But how does one go about valuing this digital property?
Crypto Fair Market Value vs. Fair Value Measurement
First, there’s an important distinction that even the most seasoned accountants often fail to recognize. While “fair value” and “fair market value” are similar, they aren’t the same.
“Fair value” typically applies to financial reporting and is defined by US GAAP as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
“Fair market value” is usually used when evaluating assets and liabilities for tax purposes. The IRS defines fair market value as “the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
In this article, we’ll focus on crypto fair market value from a tax perspective. For more information on fair value measurement of digital assets, check out our post on Principal Markets for Crypto Assets.
Was the crypto traded on an exchange?
Let’s start with the most common scenario first; crypto traded on an exchange, which also happens to be the easiest to calculate fair market value.
These exchanges function similarly to stock exchanges, with buyers and sellers determining the price of a coin based on supply and demand. The price at which a coin is traded on an exchange is often considered its fair market value. This value is typically denominated in U.S. dollars or another fiat currency (which in turn can be converted into USD), providing a clear, quantifiable value for tax purposes.
So to determine crypto fair market value, you would typically look at the trading price on the date of the transaction. It's important to note that different exchanges might have slightly different prices due to supply and demand dynamics variations. Therefore, it's best to consistently use the same exchange for valuation purposes to maintain consistency.
What if the crypto transaction did not occur on an exchange?
This can often be the case with peer-to-peer transactions, transactions on decentralized exchanges, or when earning crypto as income. In these cases, determining the fair market value can be a bit more complex.
The IRS’ guidance on this states that if the crypto is not traded on any exchange, the fair market value is whatever the crypto was worth on the date it was received. Here are a few methods that can be used:
- Cost of Goods or Services: If the crypto was exchanged for goods or services, the value of those goods or services can be used to establish a reasonable equivalent value. For example, if you performed a service valued at $500 and were paid in Bitcoin, the reasonable equivalent value of the Bitcoin received would be $500.
- Peer-to-Peer Exchange Rate: If the transaction occurred in a peer-to-peer manner, you could use the agreed-upon exchange rate between the parties. This would be the rate at which the buyer and seller valued the crypto at the time of the transaction.
- Use a Crypto Price Index: Several reputable crypto price indices (e.g., CoinMarketCap and CoinGecko) aggregate prices from multiple exchanges to provide a reasonable equivalent value for your crypto at a specific date and time.
Common mistakes and how to avoid them
Let's take a look at some of the common pitfalls you might encounter when determining the fair market value of crypto and, more importantly, how to avoid them.
The IRS loves consistency, and so should you. If you're using a particular exchange or price index to determine the fair market value, stick with it. Don't hop between different sources like a rabbit in a vegetable garden. Pick your source and stay loyal.
Remember, the fair market value of a cryptocurrency is determined at the time of the transaction. Not the day before, not the day after, not an average of the price on the day, nor is it the price at the close of business, but the exact date and time of the transaction. Keep a keen eye on those timestamps.
Detailed records of each transaction, including the date, the value of the cryptocurrency in U.S. dollars at the time of the transaction, and the method used to determine the value, are your best defense against potential audits or inquiries.
Enter Bitwave, a powerful tool designed specifically for the complexities of cryptocurrency accounting.
Bitwave integrates with various cryptocurrency exchanges and wallets, automatically pulling in transaction data. It then applies the appropriate accounting methods to calculate the fair market value of each transaction. No more manual data entry, no more wrestling with exchange rates. Bitwave does the heavy lifting for you.
It also provides detailed, audit-ready reports, making it easier than ever to keep track of your crypto transactions and their tax implications. With Bitwave, you can navigate the world of crypto taxation with confidence and precision.
Ready to see how Bitwave can transform your cryptocurrency accounting process? Don't hesitate. Request a demo today and step into the future of cryptocurrency accounting.
Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as tax, accounting, or financial advice. The content is not intended to address the specific needs of any individual or organization, and readers are encouraged to consult with a qualified tax, accounting, or financial professional before making any decisions based on the information provided. The author and the publisher of this blog post disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use or application of any of the contents herein.