You’ll be hard pressed to find someone who doesn’t agree – 2017 has been Bitcoin’s coming out party. If you are about to jump onto the crypto wagon, or are already on it, don’t forget about Bitcoin taxation.
Almost every Bitcoin or altcoin transaction – mining, spending, trading, exchanging, air drops, etc. – will likely be a taxable event for US tax purposes.
Bitcoin and other crypto currencies
While Bitcoin receives most of the attention these days, it is only one of hundreds of crypto currencies. Everything we discuss here with regard to bitcoin taxation applies to all crypto.
How the IRS sees crypto currencies
Unfortunately, the IRS has provided very little guidance with regards to Bitcoin taxation. That means some mystery remains as to how crypto taxation will ultimately take place. In fact, there has been only one IRS release mentioning crypto currency and it was in 2014.
However, one thing is clear: Although the public and crypto community refer to Bitcoin and altcoins to as virtual currencies, the IRS treats them as intangible property for tax purposes. Therefore, selling, spending and even exchanging crypto for other tokens are all likely going to have capital gain implications. Likewise, receiving it as compensation or by other means will be ordinary income.
Interestingly enough and contrary to the IRS classification of crypto currencies, in 2017, the US Securities and Exchange Commission actually ruled that crypto currencies are a currency. As a result, the SEC now regulates Initial Coin Offerings (ICOs).
Bitcoin tax implications in the US
Almost every Bitcoin or altcoin transaction will result in a taxable event for US taxpayers:
- Trading Bitcoin produces capital gains or losses, with the latter able to offset gains and reduce tax.
- Exchanging one token for another e.g. using Ethereum to purchase an altcoin, creates a taxable event. The token is treated as being sold, thus generating capital gains or losses.
- Receiving payments in Bitcoin in exchange for products or services or as salary is treated as ordinary income at the fair market value of the coin that the time of receipt
- Spending Bitcoin is a tax event and may generate capital gains or losses, which can be short term or long term. For example, you bought 1 BTC for $100. If that Bitcoin is now worth $200 and you buy a $200 gift card, there is a $100 taxable gain. Depending on the holding period, it could be a short or long-term capital gain subject to different rates.
- Converting Bitcoin to USD or another currency at a gain is a taxable event, as it is treated as being sold, thus generating capital gains.
- Air drops are considered ordinary income on the day of the air drop. That value will become the basis of the coin. When it sold, exchanged, etc., there will be a capital gain.
- Mining Bitcoin is considered ordinary income equal to the fair market value of the coin the day it was successfully mined.
- ICOs do not fall under the IRS’s tax-free treatment for raising capital. Thus they produce ordinary income to individuals and businesses alike.
As a general rule, any time you sell Bitcoin at an exchange, to another person, earn Bitcoin or buy goods or services, is a tax event for US tax purposes and in many other countries.
The crypto community has hoped that the IRS will allow for the exchange of one token for another as a 1031 like-kind exchange. However, 1031 exchanges are generally restricted to business property e.g. inventory or property held for sale to customers – not investment property such as stocks, bonds, notes, or other securities. Some personal investment property may qualify, but there are greater restrictions and it is our opinion that crypto is unlikely to fall in this category.
For the vast majority of individual crypto holders, this means there will likely be a taxable event when exchanging one token for another, even if there was no conversion to fiat.
Also note that even if the IRS does allow for like-kind exchanges through the current tax year, the new Tax Cuts & Jobs Act of 2017 limits like-kind exchanges to real property.
Specific identification and LIFO
Much like the 1031 like-kind exchange dream, many crypto investors are also hoping that the IRS will allow the taxpayer to identify the particular Bitcoin sold or exchanged, from the lot of coins from which the coin was part of. This is known as “specific identification.”
Similarly, investors are also hoping for Last-In-First-Out (LIFO) treatment to be an option. Each would allow the taxpayer the ability to manage their short and long-term capital gains. However, there is no way at this time to identify with the exchange which particular coin you are selling. Therefore it is highly likely that the IRS will default to First-In-First-Out (FIFO) treatment.
Of course this information exists on the Blockchain. However, currently the exchanges and wallets are not set up to choose which coins to sell or exchange.
Detailed record keeping
To make matters more complicated for Bitcoin taxation, digital exchanges are not brokers regulated by the IRS. That means they do not issue a 1099 form, nor do they calculate gains or cost basis for you. Many don’t even allow you to transact in dollars, instead opting for Ethereum.
We strongly recommend that you keep detailed records of all your Bitcoin or other crypto transactions. Fortunately, there are services that can take your trading history and provide you with fairly clean outputs for Schedule D on your tax return.
IRS is coming after crypto
As always, all US citizens and residents have to pay tax on worldwide income, including income from cryptocurrency. If you had more than $10k USD equivalent in aggregate holdings across your accounts with foreign exchanges on any given day, you must also report your accounts on FBAR filings. In addition, your host country or country of business may impose different Bitcoin tax rules.
With only several hundred people reporting their crypto gains each year since Bitcoin’s launch, the IRS suspects that most crypto users have been evading taxes by not reporting crypto transactions on their tax returns. The recent order for Coinbase to hand over user records to the IRS indicates the determination of the IRS to stop this tax evasion.
Without a doubt 2018 will be a landmark year for IRS enforcement of crypto currency gains. Given the level of information stored on the blockchain it is likely only a matter of time until IRS audits catch up with the increased use of digital currencies.
Taxpayers should stay ahead of the game, rather than be reactionary. The IRS is always more lenient with taxpayers that come forward on their own accord rather than those that get discovered. Coming forward now could actually be the difference between criminal penalties and simply paying interest.
How to deal with crypto taxation
Not all tax accountants have experience with Bitcoin taxation. We have helped numerous clients in the crypto space, including high volume traders and miners.