April can be a stressful time of year for U.S. citizens obliged to complete tax returns. For those with cryptocurrency investments, it can feel particularly painful thanks to the legal gray areas left by the IRS.
Over the past few years, tens of thousands of taxpayers have been forced to file earnings based on incomplete guidance that has been open for interpretation. So what are citizens to do? Most people want to stay on the right side of the law, but no one wants to (or should) pay more than they are required to. Calculating the right balance can prove a challenge.
In light of this absence of certainty, the general message to investors is to carefully record their crypto investment transactions to avoid finding themselves in the crosshairs of the IRS. Hiding isn't a good strategy – especially when you consider recent powers awarded to the IRS that allow them to compel crypto exchanges like Coinbase to hand over all users' transaction records.
So let's look at what investors need to know – and the gray areas they and their advisors need to pay particular attention to.
Crypto = Property
The IRS considers virtual currency as property. This means general tax principles applicable to property transactions apply to virtual currency transactions. Think of capital gains as being akin to stock gains. If you purchased 10 BTC for $10,000 at the start of 2017, then sold them mid 2018 for $50,000, you have a taxable capital gain of $40,000.
While cryptocurrency is property, it isn't real property. As such, as of 2018, the like-kind exchange rule under IRC code section 1031 doesn't apply. If you buy one coin and sell it to buy another, any gain is subject to tax (just as if you had sold Bitcoin to buy your new home). It might be difficult for active traders to keep accurate records of exchanges — but make sure you do (the right crypto-specific software can help recover your trade history) as without them calculations can become difficult.
Gains from Forks
The IRS hasn't offered specific guidance on the tax treatment of cryptocurrency that is received in a fork. For such a significant issue, this is frustrating and perplexing. Remember, Bitcoin forked a number of times in 2017. The Bitcoin Cash fork alone doubled every holder of Bitcoin's amount of Bitcoin-like digital currency.
A handful of accountants and advisers believe that the value of the coins received is treated as taxable income on the date of the fork.
Yet other experts (including myself) feel tax should only be paid when investors sell the forked coins. They posit it should be a gain of the asset's value at the date of disposition. Telling people to pay income on value they never had a choice in receiving (and didn't have the power to even reject) is illogical and in conflict with the spirit of tax laws.
Unfortunately, this is a murky area and the most prudent course of action for taxpayers and their advisors is to show honest and transparent workings in their tax applications that affords at least a reasonable basis for being sustained if challenged.
Foreign Crypto Assets
Taxpayers may be required to report foreign crypto accounts that exceed (at any time during the relevant tax year) certain figures. You need to be ready to fill in an FBAR (the Report of Foreign Bank and Financial Accounts) if the aggregate maximum value of your account(s) exceeded $10,000 at any time throughout the year. If the balance of all crypto held on foreign exchanges exceeds $50,000 on the last day of the year, you may be required to complete Form 8938 (Statement of Specified Foreign Financial Assets).
Don't be tempted to simply close accounts held abroad without reporting. The IRS has several methods of discovering foreign investments. It can use subpoenas (as it has used against Coinbase) and has specialised software that can examine files. The appearance or action of covering up wrongdoing may expose you to penalties, including criminal charges.
If you've ever received virtual currency as payment for goods or services, the market value on the date the virtual currency was received must be included in your gross income. Similarly, if you've paid for work performed for you in crypto, the gain or loss on the value of the crypto used should be calculated on the date of payment.
The Need for Transparency
Although not explicitly spelled out in the guidelines, specific identification of each piece of digital asset received should be tracked as it is moved from wallet-to-wallet and from exchange-to-exchange. This falls directly within the spirit of the guidelines by treating cryptocurrency as property and not an actual currency.
Crypto-specific accounting software exists today to manage this activity and we believe it's the only way to irrefutably account for income, gains, and losses. Only through specific identification can one calculate gains and losses that may be independently verified by auditors.
Finally, one last piece of advice. If you've had a Coinbase account before 2016/2017, it's important to take steps to mitigate potential consequences you face. This may include amending past tax returns, filing missed returns, or making voluntary disclosures. A crypto tax expert would be a big help here.
Also published in BlockTelegraph.