Cryptocurrency is hot right now. As it emerges as an asset class of its own, many people are still confused how to treat it for federal income tax purposes. In response, the IRS issued guidance back in 2014 that treats virtual currencies that are convertible to cash as a capital asset – but it’s not as simple as it appears.
Taxable Events and Imputed Income
A major concern for the IRS is that coin-to-coin trades and buying items and services with coins are often mishandled for tax reporting purposes. The IRS considers these all to be taxable events, but this might not be evident to most people. Coin holders are supposed to “impute” an exchange transaction and report gains/losses in all these cases.
While it might seem absurd to have to report a taxable event each time you buy or sell something, remember that the IRS considers cryptocurrencies intangible property and not actual money, which makes the crucial difference.
Coin to Cash Transactions
Capital gains and losses are the difference in the price you sell the asset at (minus transaction costs such as commissions) and your basis in the asset. Your basis is what you bought the asset for (plus transaction costs such as commissions). These types of transactions are straightforward and common sense – just think of buying and selling a stock.
Coin to Coin Transactions
Cryptocurrency traders often exchange one type of coin for another, such as trades like Bitcoin to Ethereum. Purchases of alt coins usually require using another coin such as Ethereum – you simply cannot purchase some cryptocurrencies with U.S. dollars directly.
Some taxpayers delay capital gains recognition in situations such as these by treating coin-for-coin trades as Section 1031 exchanges; however, the new tax law has eliminated this treatment for sure and it was questionable at best before.
Let’s look at a simplified example of a coin-to-coin trade and the tax consequences. Say you bought 1 Bitcoin for $3,000. Now it is worth $12,000 and you exchange it for 10 Ethereum. Technically, you have a taxable gain of $9,000 ($12,000 minus $3,000 basis) and your new basis in the 10 Ethereum is $12,000.
Coins for Goods Transactions
Similar to coin-to-coin transactions, using a cryptocurrency to purchase goods or services is a taxable event. Let’s look at an example of how this works.
You were brilliant and bought some Ethereum in early 2017 for $12 per coin and now it is worth $1,100 per coin. Feeling rich, you wander over and buy yourself a new Aston Martin DB11 for 196 Ethereum coins, or the equivalent of $215,600 cash. Aside from being the proud new owner of a fine sports car, you also owe the IRS taxes on $213,248 in gains (196 coins x $1,100 value at purchase, minus your $12 cost). Hopefully you have some cash or coins left over to cover the tax bill.
Investing in Cryptocurrency Outside the United States
You do not need to report your cryptocurrency on your FBAR, according to an IRS statement issued in 2014. The IRS confirmed this position again for 2017.
Big gains in cryptocurrency prices over 2017 mean there is A LOT of tax money at stake, and the IRS is cracking down in an effort to get what they consider their fair share. They are using legal efforts to force major exchanges such as Coinbase to turn over customer records and institute reporting measures to stop fraud. Stay ahead of the IRS and make sure you report your cryptocurrency trading properly.
Dee Ann Creach serves as a tax planning and compliance expert for McConnell & Jones where she leads the preparation of hundreds of tax returns. With more than 30 years of experience, clients value the ability to tap into Dee Ann’s extensive experience in public accounting—which, in addition to income tax services, includes strategic family business, gift and charitable planning as well as financial consultative services. As tax manager, Dee Ann also oversees correspondence with the IRS and state governments, helping to save clients hundreds of thousands of dollars in unnecessary remittances. Connect with Deeann on LinkedIn.