Learn all the tax ramifications of buying, selling, and trading cryptocurrencies
What is Bitcoin? Is it currency? Is it a commodity? Is it a passing fad doomed for a crash or a permanent sea change in investment and commerce? Only the future will determine the answer to that latter question, but how cryptocurrencies like Bitcoin, Litecoin, and Etherium are treated by the Internal Revenue Service is very much an issue of immediate concern.
As the market for these innovative currencies explodes and the value of “tokens” rapidly increases, the IRS is actively working to ensure that it gets its cut of the action.
What are Cryptocurrencies?
While Bitcoin with a capital “B” is one of many cryptocurrencies, bitcoin with a lowercase “b” is often used as shorthand for all such currencies. With that said, bitcoin is a distributed, peer-to-peer digital currency that functions without the intermediation of any central authority.
Bitcoin’s creation, value and integrity is based on “blockchain” technology, which regulates the creation of new units called “tokens” and provides the security for all digital currency transactions. You can learn more about what bitcoin is, how it works, and how you can use it here.
How Does the IRS Treat Cryptocurrencies?
Bitcoin and its brethren are both fish and fowl in the sense that they can be used to make purchases and payments like currency but can also be kept as an investment like gold and other precious metals.
The IRS has ruled that bitcoin and other digital currencies are not currency but rather are considered property for tax purposes. While you may not receive a 1099 for your bitcoin transactions, Uncle Sam will expect you to pay the applicable taxes on any capital gains or losses you derive from the value of your bitcoins.
You should always consult with an experienced accountant as to how to treat your bitcoin interests for tax purposes. Generally, however, if you held a bitcoin investment for one year or less, it will be considered a short-term gain and taxed as ordinary income. Any sale of digital currency you make after owning it for more than one year will be treated as a long-term gain.
How Will the IRS Know I’ve profited from Bitcoin? Isn’t it anonymous?
One of the perceived benefits of cryptocurrency is its anonymity and security. Since no one is providing 1099s or other reporting to the IRS, it may be tempting to believe that you can get away with keeping your bitcoin transactions off the books without worry.
Don’t be so sure. In November 2017, a U.S. District Court judge in California ordered Coinbase, a popular platform for buying and selling bitcoin and other cryptocurrencies, to hand over personal information (name, address, taxpayer ID, etc.) about anyone who bought, sold, sent, or received at least $20,000 during the period between 2013 to 2015. Coinbase estimates that the order effects 14,355 users. The IRS had initially requested personal information for all of the estimated one million users of the trading platform.
How the new 2018 Tax Bill closes cryptocurrency loophole
That action is hardly going to be the last word on the government’s efforts to track and exact taxes on bitcoin transactions. The sweeping tax bill that was recently signed into law closes a loophole that many cryptocurrency investors had used to avoid taxes.
Prior to the passage of the new bill, many purchasers and sellers who traded one type of cryptocurrency for another (e.g., trading Bitcoin for Litecoin) treated it as a “like-kind” exchange under Section 1031 of the tax code, meaning that it did not trigger a “tax event.” Under the new law, however, Section 1031 was rewritten to apply only to “real property,” thus excluding all other types of property, including cryptocurrency, from its protections.
Needless to say, legal and tax issues involving Bitcoin and other cryptocurrencies are constantly evolving. If you are investing in the digital currency marketplace, make sure you consult with an accounting and tax professional. If you have any questions, please contact us. We welcome the opportunity to assist you.