Understanding Cryptocurrency and Fair Market Value

Fair Market Value (FMV) is a metric used by the Internal Revenue Service (IRS) to determine the value of an asset at the time of a transaction to determine tax requirements. 

You may wonder what this has to do with cryptocurrency. In the eyes of the IRS, you are liable for capital gains tax if you buy cryptocurrency and sell it at a higher price. The FMV determines this tax. 

However, the FMV, unlike the market value of an item, is not set by the seller alone; it depends on several parameters. If you are a heavy trader in digital currencies, the shifting nature of FMV can make filing your taxes quite a headache. It’s essential to get this right to stay compliant with the IRS. 

What Is Fair Market Value?

Fair market value is not merely the price, or market value, of an item at a particular time—it is the value of an item taking into account the principles of open market trading. 

According to these principles, neither the buyer nor the seller should be under pressure to enter the transaction. Both parties should also have ample time to decide what best serves their interests. Similarly, both parties should be fully aware of all relevant product information while entering the transaction.  

Why Is Fair Market Value Important For Crypto?

Due to the many considerations that go into determining fair market value, you don’t usually use it during the transaction. FMV comes in handy in legal matters and when processing insurance claims. It is also the IRS’s yardstick in determining how much tax you need to file for different types of cryptocurrency transactions. 

The first consideration that goes into fair market consideration is whether or not the buyer completed the sale through a centralized cryptocurrency exchange. If so, the crypto value recorded by the exchange in dollars is considered its full market value. 

Recording the transaction onto a blockchain or not is another critical determining factor in calculating the crypto FMV. If reported, the crypto’s value recorded on the public ledger at the transaction time is considered its full market value. If it was a peer-to-peer transaction that did not involve a currency exchange, the crypto value at the date and time of the transaction in the distributed ledger (blockchain) is the accepted FMV.

Maybe you didn’t buy the digital currency from a crypto exchange. What if it was given to you in exchange for goods or services and was valueless at that time as it was new and unpublished? Then the value of goods or services exchanged for crypto will be taken as the FMV.

How To Calculate Fair Market Value

There are several ways the IRS will expect you to calculate the FMV from your virtual currency transactions:

  • Determine the value of the currency reported by the crypto exchange at the time of the transaction.
  • Utilize pricing from the global price index at the date and time of transaction.
  • If the transaction didn’t happen on an exchange, you are still required to base the FMV on the currency’s spot value at the trade time.

There are several websites where you can look up the fair market value of your preferred cryptocurrency. Coinfairvalue.com offers FMV values based on the usage of a unit of that particular currency. Others like Coinmarketcap.com calculate FMV by getting the median average of a currency’s spot values in exchanges worldwide. 

Identifying fair market value and subsequent taxes can present a considerable challenge to many in the crypto world. For this reason, you may want to get help from a cryptocurrency tax accounting service

Winning With Cryptocurrency

If you’re getting into cryptocurrency investment, you need to arm yourself with all the information you can to improve your chances of making lucrative returns. Being well informed on what the IRS expects from you will prevent you from spending more on cryptocurrency tax than you should. It will also help you avoid possible penalties for non-compliance. Never hesitate to ask for help if you feel you’re in over your head.