2017 has been a banner year for Bitcoin and other cryptocurrency. But along with this success comes confusion around taxation. We are here to help!
IRS Notice 2014-21 is the only guidance to date that the IRS has provided regarding cryptocurrency. What they told us is that they consider crypto to be property, not currency. As property, the holder is required to track cost basis, and realization is subject to capital gains treatment.
When Is Cryptocurrency Taxed?
Crypto is taxed only when you converted it to something else, either fiat or another coin. Depending on how long you have held the coin, it is subject to short or long term capital gains. Only the realized gain is subject to tax. That means if you bought $1000 worth of BTC, and a month later sold it for $1500, you would be taxed only on the $500 profit at short term rates.
Exchanging fiat for coin is not a taxable event, but it is important to record your basis information. This is how much you coin you bought, when you bought it, and how much USD you spent.
Exchanging coin for fiat must be reported on your annual 1040, on form 8949, which flows to Sch D. When you report it, you need all of the following information: Date Acquired*, Cost Basis (This is what you initially paid for the coin), Date Sold, and Sales Proceeds. With this information, you can calculate the net gain and whether it is short-term or long-term.
*Various is acceptable here as long as all transactions in the group are either short- or long-term.
Coin For Coin
Exchanging one coin for another coin is considered a taxable event. Some have argued that a 1031 like kind exchange can be made for crypto, but Sec 1031 indicates this is not the case. Even if the coin is not converted to USD, the USD value equivalent needs to be reported. For example, If I have 1 ETH, and I convert it into 4.5 LTC, where the USD value of ETH is $450 and LTC is $100, I would need to close out the ETH holding by calculating the gain. If I bought that ETH for $300, I would show selling 1 ETH on today’s date with a basis of $300 and a sales price of $450. I report $150 as a capital gain, and my basis in LTC is now $450.
Purchasing Goods and Services
Buying a sandwich with BTC may seem like a great idea, but it comes with tax consequences. Effectively, you are converting your BTC to a sandwich, and need to recognize the gain on the BTC as if you converted it to USD. If your basis in the BTC is $8 and the sandwich is $10, you have a $2 capital gain that needs to be reported.
Since the IRS has neglected to issue guidance on this subject, these are the prevailing theories among tax pros, using Bitcoin Cash as a specific example:
BCH has a basis of 0, and an acquisition date of 8/1/17. (This is what I lean towards in advising my clients)
BCH basis is prorated against the ratio of BCH:BTC on 8/1. (Roughly 9% depending on how you calculate it.) BCH acquisition date is the same as the original BTC.
Some pros believe you need to recognize the value of BCH on 8/1 as “other income,” and pay tax on it. This value becomes your basis in the BCH.
I don’t agree with #3 for a number of reasons, primarily, the exact value of BCH on 8/1 is very difficult to determine. It was hours between blocks, so when do you calculate the price? Also, this would impose ridiculous requirements based on the countless hard forks across all coins that fizzle out immediately afterward but may have had some speculation value. This is the same problem with option #2. Every fork would require you to dilute your basis in the original coin.
Mining is handled very differently as you are basically creating value from nothing. Gross proceeds from mining should be reported on Schedule C. Appropriate deductions/depreciation for electricity, internet, mining rigs, etc should be taken as well. You will be subject to income and self employment tax on the net gain, but the net will also become your basis in the mined coin. This area of crypto can become very complicated very quickly. Feel free to contact us to talk about your individual situation.