Earlier this month, cryptocurrency traders gathered in Manhattan.
One attendee later observed that “they looked a little shell-shocked.”
As well they might.
Last year’s booming crypto market made many of them millionaires. Bitcoin’s price rose more than 1,500% last year … before diving 44% so far this year.
But that’s not the reason many attendees had the thousand-yard-stare.
They were worried about the IRS.
You see, many of them had sold bitcoin in December to lock in profits. They’d used the proceeds to buy new cryptocurrencies with steeper price trend lines. Those newer crypto assets, however, had suffered steep losses in 2018.
So now the traders lacked the dollars to pay the IRS for their 2017 capital gains on bitcoin. Some of those tax bills ran into the hundreds of thousands of dollars.
Sadly, the IRS doesn’t accept bitcoin. And it doesn’t take “oops” as an excuse … even in the exciting new world of virtual money.
Crypto Assets? Exactly.
The IRS agrees with us: Current tax rules treat cryptocurrency as an asset rather than a currency.
That means every time you sell or transfer a digital coin for something else — dollars, another cryptocurrency or a slice of pizza — you’re creating a taxable event involving capital gains or losses.
Let’s say you acquired $100,000 in bitcoin in January 2017. By December, it would have been worth around $1.5 million. You then sold $1 million worth of bitcoin for dollars and invested it in some other hot initial coin offering.
That big windfall gain put you into the top tax bracket, so you’d owe the IRS almost $370,000 in capital gains taxes.
You’d owe the same amount even if you’d used $1 million in bitcoin to buy gold, a car or a house. The value of bitcoin had increased, and you realized that gain when you converted it to another form, triggering a taxable event.
At least the tax on a one-off event like that would be easy to calculate.
Imagine you had traded bitcoin hundreds of times last year, both for speculation and to buy stuff. Every single transaction must be accounted for as a short-term capital gain or loss … and reported on your 2017 tax return.
Virtual Money, Real Laws
Most of the attendees at the Manhattan event admitted that most traders had never paid taxes on their crypto gains and weren’t planning to start.
After all, Satoshi Nakamoto invented bitcoin to create a government-free financial space. And the blockchain is anonymous, right? How’s the IRS gonna know?
Turns out, it’s not difficult to find out.
In 2013, the IRS formed a team to study the use of virtual currencies to avoid taxes. Over the next two years, the team prepared a case seeking the identities of all U.S. customers of Coinbase from 2013 to 2015. Eventually the IRS narrowed that down to 14,000 customers who had made trades of $20,000 or more.
In its filing, the IRS noted that although Coinbase boasts nearly six million customers, fewer than 1,000 U.S. taxpayers have ever reported cryptocurrency gains to the agency.
On November 29 last year, a federal judge ruled that Coinbase must turn over those users’ names, birth dates, addresses and taxpayer IDs, along with records of all account activity.
For those folks, the crypto-party is over. They face a future of interest charges, penalties and audits.
Crypto and Tax: What You Need to Know
If you’ve ever traded in a cryptocurrency, tack this summary up on the wall as a reminder of what you need to do before April 15.
• The IRS treats cryptocurrencies as assets, like stocks or bonds. Any gains or losses when you dispose of a cryptocurrency are calculated against its market value when you’ve acquired it (your “basis”). Gains are taxed at the capital gains rate. Losses can be used to offset other capital gains and income.
• The same applies if you buy something with a cryptocurrency. Over 100,000 companies accept bitcoin, including Microsoft and Expedia. Every software or airline ticket purchase triggers a taxable event and must be reported accordingly.
• Although cryptocurrencies aren’t money for tax purposes, any time you’re paid in cryptocurrency, it’s taxable income. It’s the same as if someone paid you with a new car instead of cash. If you’re a contractor and you’re paid in cryptocurrency, you must pay self-employment tax as well as income tax on any crypto receipts.
• If you pay a contractor $600 or more in cryptocurrency, you have to file a Form 1099 and report that payment to the IRS.
• Exchanges like Coinbase aren’t required to report cryptocurrency transactions to the IRS, as your stockbroker would do (Form 1099-B). That means you are personally responsible for keeping track of every move you make in the crypto space, tallying transactions on Form 8949 and reporting net gains or losses on Schedule D.
• You cannot characterize a cryptocurrency sale whose proceeds are used to buy another cryptocurrency as a 1031 exchange. The new tax law limits 1031 exchanges to real estate only.
No One Said It Would Be Easy
In all the excitement about crypto assets, it’s easy to overlook the fact that they’re the centerpiece of a political struggle. You should expect aggressive tax enforcement in the crypto space to be part of this ongoing struggle.
Many people like cryptocurrencies because they promise an escape from government control. Governments know this and are fighting back. The pace of government action in the crypto space has increased dramatically since the beginning of this year.
However, most of us invest in crypto assets because they’re potentially profitable. You may not be interested in politics. Unfortunately, politics are interested in you.
Editor, The Bauman Letter
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