A breakdown of Tax Implications, current IRS guidelines, court case, basic to complex issues when dealing with cryptocurrency or virtual currency, federal tax filing, how to possibly save tax? and record keeping on cryptocurrency and taxes.
We are going to hit the core issue of “Tax Implications” and then take a deep dive into what IRS and treasury department is saying and doing? Basic to Complex issues when dealing with cryptocurrecy and what you should do?
If you are an investor or a cryptocurrency trader, you must know the following points:
- Trading a cryptocurrency currency to any other cryptocurrency currency in other words crypt-to-crypto is a taxable event.
- Trading a cryptocurrency currency for goods and services is a taxable event.
- Trading cryptocurrency to any legal tender is a taxable event.
- If you gift cryptocurrency currency to someone, it is not a taxable event up to gift limitation amount. Any amount above gift limitation is subjected to filing and taxes by the person giving the gift.
- A wallet-to-wallet transfer of cryptocurrency is not a taxable event if owner of the both wallets is the same person.
- If you buy any virtual currency with USD, it is not a taxable event until you trade, use, or sell it.
What is IRS saying and doing?
For tax purposes, cryptocurrency is treated as a capital asset. So what is a capital asset? Per IRS, “capital assets include most property you own for personal use or as an investment (stocks and bonds)”. In 2014 IRS issued guidelines, which stated selling or buying of cryptocurrencies will be subjected to capital gains which is similar to buying and selling of stocks, bonds, and other investments. Further, if you are using cryptocurrencies to buy and sell goods, or other cryptocurrencies, then each transaction calculated based on the fair market value on transaction date will result in a gain or a loss as well. In a nutshell, anything other than buying, holding and transferring is a taxable event calculated based on fair market value at the transaction date and subject to capital gains rules.
Case Number 3:17-cv-01431
Court: California Northern
Nature of Suit: Taxes
Judge: Jacqueline Scot Corley
On November 28, 2017, The IRS had a partial win in its bid to seek records from Coinbase Inc., when a California federal judge directed the virtual currency exchange to handover all the information on accounts with transactions of greater than $20,000. Judge Corley also ordered Coinbase must provide the taxpayer’s name, address, and date of birth for the accounts, but not copies of driver’s licenses, passport, public keys, and wallet addresses for accounts as these documents were not relevant.
Further, a 31-page report from Treasury Inspector General for Tax Administration dated September 21, 2016 clearly reflects a virtual currency issue team has been formed in IRS but compliance regulations are yet to be developed. The report suggest revision of third-party reporting requirements and documents, guidance for tax treatment, and developing a cryptocurrency strategy.
The Court case and Treasury Inspector General for Tax Administration clearly shows the intent, direction and position IRS is taking to combat the issue of tax on cryptocurrency. As per the IRS, the transactions made through virtual currencies are not been reported on the tax forms due to which these currencies can easily be used for illegal activities. Also, these currencies can be used by the criminals to trade their dirty money for goods and services.
The new US Tax bill has banned all the like-kind exchanges in 2018 that are not related to real-estate, even if the like-kind applies for 2017. But, there might be a chance for you to make a case for like-change in 2017 by hiring a tax professional. However, this is only possible if have treated the cryptocurrency as an investment property.
Basic to Complex Issues in detail:
Cryptocurrencies have become a trend these days with more and more investors investing a lot into these virtual currencies. On top of that, they have made lots and lots of profits. That being said, there are still many people who actually don’t know about how federal taxes work in case of cryptocurrencies.
Selling and buying cryptocurrency as an investment is just like selling and buying stock. Calculate gain or loss by knowing the basis, holding period (“HDOL” crypto lingo) and a triggering event. The concept also applies to treating cryptocurrency like a cash.
Let’s try to understand the detailed concept of taxes in case of cryptocurrencies:
From the time you acquired the asset, the variation in your cost basis, until a taxable event, will determine your capital gains and losses. Here, cost basis is the actual cost you pay for the asset, wherein if you purchase a new asset or reinvest in the asset (in this case cryptocurrency), your cost basis will increase. Also, when you pay commissions and fees while trading the cryptocurrency, those commissions and fees are also included in the cost basis. According to the tax law, till 2017, you can deduct any investment related fees on your Schedule A, but for 2018 through 2025, this rule has been eliminated. On the other hand, if your business owns the asset, you can still deduct the investment related fees on the Schedule C.
Another factor to consider while dealing with cryptocurrencies is the taxable event. Generally, a taxable event is when you sell or dispose of your assets. Similarly, in case of cryptocurrency, a taxable event is when you trade the currency for cash, goods and services, or any other cryptocurrency. While filing your tax, you can use your transaction summary provided by various companies. If you cash-out your cryptocurrency from an exchange, it will be treated as a sale because the exchange can no longer determine what you did with the cash.
Another question that arises is about Tax Rates in case of Capital Gains. For the year 2018, in case of Long-term gains, the capital gain rates range from 0% to 20%. In case of Short-term gains, you will be taxed similarly as of your normal income. It should be noted that Long-term gain is when you hold a cryptocurrency for more than a year before a taxable event. On the other hand, a Short-term gain is when you hold a cryptocurrency for a year or less before a taxable event. The taxable event will include all the transactions made using cryptocurrency and not only the cash-outs.
Now, what will happen if you lose money? For tax purposes, you have a capital loss only when your realized losses exceed your realized gains. In that case, you can claim up to $3000 of capital losses. If your losses exceed the limit, it can be forwarded to the coming years. You must be wondering what does realized gain or realized loss means? Suppose you invested $5000 in a cryptocurrency. Suppose the value of the cryptocurrency climbs up and your $5000 worth of currency has now a value of $7000. This is an unrealized gain because you never made any additional investment. Similarly, suppose the value drops to $3000, this will be then an unrealized loss. In both the cases, there will be no capital gain or loss unless and until you sell the asset. Hence, you don’t have to report anything if you don’t have any realized gain or loss.
What you should do?
Federal Tax Filing
It will be a clear mistake to think that you can get away without paying what you owe to the IRS. Whatever profit you make from cryptocurrencies, you have to pay the taxes. Simply assume that IRS has all the data related to your trading history, and they will reach out to you if you miss out on your taxes. After all, you do not want to be an example for those who are also involved in virtual currency tax fraud. So, report all short and long term gain on Schedule D and if you are a day trader then report ordinary income or loss.
How to possibly save tax?
Do some tax planning and hire a CPA or tax professional to see if you should incorporate or not and how you can qualify for qualified business deduction under the new tax law. If you are planning to trade on regular basis then incorporation could be another way. Again, don’t do this yourself and get help from a professional.
- In case of trading virtual currency for goods and services, you must always keep a record for every single transaction and report as per the fair-market value of the virtual currency at the time of the transaction.
- In case of trading a virtual currency as a capital asset, here also, you must record and report every single transaction as per the fair-market value of the virtual currency at the time of the transaction.
Hiring the right CPA or tax professional is the key to navigate through uncharted territory of cryptocurrency taxes. Contact us if you want more information or are concerned about previous years tax returns.