Answering the 1040 Digital Asset Question

When preparing a federal income tax return, every filer must answer a specific question regarding digital assets. The Internal Revenue Service (IRS) requires a response from all taxpayers, even those with no connection to cryptocurrency or other digital holdings. Answering this question accurately is the first step in satisfying tax obligations for this asset class. This guide clarifies the question, helps determine the correct response, and outlines any required reporting.

The Digital Asset Question Explained

Near the top of Form 1040, U.S. Individual Income Tax Return, filers will find the question. For the 2023 tax year, the IRS asks: “At any time during 2023, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” This question appears on the main individual tax form and its variations for seniors and non-resident aliens.

The IRS defines a “digital asset” as a digital representation of value recorded on a cryptographically secured distributed ledger or similar technology. The most common examples are cryptocurrencies like Bitcoin and Ethereum, which are forms of convertible virtual currency.

The definition also includes stablecoins, which are digital assets designed to maintain a stable value relative to a real-world asset, such as the U.S. dollar. Another prominent category is non-fungible tokens (NFTs), which are unique digital identifiers that cannot be copied or substituted, often representing ownership of a digital or physical item.

Determining Your Answer

Deciding whether to check “Yes” or “No” depends on your specific activities during the tax year. The IRS provides clear guidance on which actions fall into each category. A taxpayer’s response dictates whether further reporting of gains, losses, or income is necessary.

Activities That Require a “Yes” Answer

A “Yes” answer is required if you engaged in certain transactions. These include:

• Receiving digital assets as payment for goods you sold or services you provided.
• Selling a digital asset for cash, whether U.S. dollars or another real currency.
• Exchanging or trading one digital asset for another, for instance, trading Bitcoin for Ethereum.
• Using a digital asset to purchase an item or service.
• Receiving new digital assets from mining or staking activities. Mining involves using computer power to validate transactions on a blockchain, while staking involves locking up digital assets to help secure a network.
• Receiving new assets from a hard fork, which occurs when a cryptocurrency’s blockchain splits into two.

Activities That Allow for a “No” Answer

There are a few specific situations where a taxpayer can check “No.” The most common scenario is holding a digital asset in a wallet or on an exchange for the entire year without any transactions. If your only activity was purchasing digital assets with real currency, such as U.S. dollars, and you continued to hold them, you can answer “No.”

Another activity that permits a “No” answer is transferring digital assets between wallets or accounts that you own and control. For example, moving Ethereum from a hardware wallet to an account on a centralized exchange that you own does not require a “Yes” answer. These exceptions prevent taxpayers who are merely buying and holding from being flagged for additional reporting.

Reporting Requirements for a “Yes” Answer

Checking the “Yes” box on Form 1040 signals to the IRS that you have engaged in a reportable digital asset transaction. This answer means the details of that activity should be found elsewhere in your tax return. The IRS treats digital assets as property for tax purposes, so the principles that apply to transactions involving stocks or other capital assets generally apply.

For investors, the primary forms for reporting are Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. Form 8949 is used to detail each sale or exchange, requiring information like the date you acquired the asset, the date you sold it, your proceeds, and your cost basis. The totals from Form 8949 are then summarized on Schedule D to calculate your net capital gain or loss.

Income from certain digital asset activities is reported differently. If you received digital assets as payment for services as an independent contractor, this income would typically be reported on Schedule C, Profit or Loss from Business. Income from activities like staking or mining that do not constitute a business is generally reported as “Other Income” on Schedule 1 of Form 1040.