(Updated Oct 09, 2019)
For the HODLer,
the crypto day trader,
the boss who pays employees in cryptos,
the employee who receives payment in cryptos,
those who received air-dropped tokens, forked coins or tokens, and
those who exchanged coins for different ones...
Let’s discuss the tax implications.
You could owe the taxman money if you:
Actively buy and sell crypto
Pay someone wages in crypto
Receive wages (W-2) or income (1099) for work performed
Purchase goods or services with crypto
Receive air-dropped crypto
Receive crypto because of a chain split (i.e., fork)
Exchange one cryptocurrency for another
The Internal Revenue Service (IRS) issued Notice 2014-21, which gives taxpayers some guidance on the tax treatment of transacting in cryptocurrencies, or as the IRS refers to them, “virtual currencies.” More recently, the IRS issued Revenue Ruling 2019-24 and updated Q&A format guidance, which gives taxpayers further tax guidance on cryptocurrencies, specifically around hard forks and airdrops (you may have taxable income to report on that bitcoin cash fork back in August 2017!).
Basically, the IRS treats virtual currencies as property. This means that if, for example, you bought bitcoin (BTC) with U.S. dollars (USD) on January 1st, exchanged it for ether (ETH) on June 30th, and then sold the ETH for USD on July 1st of the following year, you would have two separate taxable events, one on June 30th and one on July 1st of the following year, but the tax rate applied when you exchanged BTC for ETH will likely be different (i.e., higher) than the tax rate when you sold ETH. This is because property held for one year or less is subject to short term capital gains treatment when sold or exchanged, which in most cases will be a higher rate than long term capital gains rate, which is applied to sold or exchanged property that was held for more than one year.
What does all this mean to you?
It means that it’s extremely important that you track the quantity, price (in USD) and date of when you buy, sell, receive, spend or exchange cryptos (in tax parlance, this is called basis tracking). There are online basis calculators that can help you keep track of your transactions.
There are other tax traps that crypto enthusiasts may not be not aware of, such as:
Offshore exchanges and digital wallets that are operated by foreign third-party providers may be subject to FBAR and FATCA reporting requirements (failure to report could mean stiff civil penalties and potentially criminal penalties of up to 5 or even 10 years in prison!).
As alluded to previously in this article, as of January 1, 2018, taking a section 1031 like-kind exchange election with respect to cryptos will probably not pass muster with the IRS (i.e., when you convert your bitcoin into ether, you may now have a taxable event).
Other than a couple of narrow exceptions, losses (e.g., theft via a hacked wallet) are no longer deductible for tax purposes.
Holding cryptos can make your tax situation more complex; and this article doesn’t even cover other important aspects of investing in cryptocurrencies that you might not be aware of! We strongly recommend that you seek the advice of a tax professional if you hold or have ever transacted in cryptocurrencies.
Need tax help with your cryptoassets? Please contact us here to set up a free consultation. Want to learn more about cryptocurrencies, taxes and financial planning? Check out this podcast published by the American Institute of Certified Public Accountants (AICPA). Mercer Street offers financial planning and investment management services to professionals and small business owners, as well as business consulting and tax compliance services. We specialize in advising on cryptocurrencies. Check us out at www.mercerst.io.