For most taxpayers, earning a tidy profit on crypto-currencies like Ethereum and Bitcoin has been relatively simple in 2017.
However, with the passage of the new tax bill, those profits will be subject to much closer scrutiny by the IRS.
For example, federal tax law is especially tricky when it comes to swaps between different types of coins (Bitcoin and Litecoin, for example), and in cases where coins do their version of a stock split, known as a “hard fork” in the crypto business.
The IRS, according to its own website at IRS.gov, is clear about the fact that they want to collect tax on every exchange, sale and split of crypto-currency.
According to Fortune and other financial media outlets, federal tax authorities have noted that very few taxpayers are reporting sales and exchanges of crypto-money.
In late November, 2017, a San Francisco federal court ruled that the largest crypto-currency platform, Coinbase, must turn over client data to the IRS. After lengthy arguments throughout the case, Coinbase was able to limit the data seizure to just 3 percent of the original number of records the IRS sought. But in the end, the feds will get Coinbase’s records on any U.S. taxpayer who traded, bought or sold in excess of $20,000 worth of crypto-currency, according to the ABA Journal.
Many CPAs and tax attorneys now specialize in crypto transactions as Bitcoin and similar assets continue to gain popularity with average investors.
If you are one of the millions of U.S. citizens that sold, exchanged, purchased, or somehow made a profit on any crypto-currency during 2017, you need to know the following:
Swaps: According to the new tax law, swapping one crypto for another is a taxable event (a capital gain, in this case), plain and simple, whether you “park” the initial sales proceeds with a third party or not.
The new tax law no longer allows crypto-currency activity to take advantage of the 1031 “like-kind property exchange” shield. That’s because lawmakers were careful to define “property” in the new legislation as real estate only.
Reporting for foreign assets in your portfolio
If you owned more than $10,000 of foreign-based assets, you will likely have to file IRS form 8938 and FinCEN report 114. The definition of “foreign-based” is a bit murky, but if your crypto-currency is held in a non-U.S. account or primarily situated in a foreign nation, you will be subject to reporting requirements.
Holding periods matter
If you hold a crypto asset for less than one year, the gain on sale will be treated as a short-term one, and be taxed at a 37 percent rate. To enjoy the lower, long-term treatment of between 0 and 20 percent, you’ll need to hold your crypto-currency for more than one year. And don’t forget about state taxes on these transactions, which can amount to something between 3 percent and 13 percent.
What is a hard fork, anyway?
Crypto-currencies often make “upgrades” for various reasons, similar to an old-fashioned stock split. For example, Bitcoin recently issued “Bitcoin cash” to all coin holders at the time of the upgrade/split. Under the new tax law, even though this exact kind of event is not delineated, it’s safe to say any kind of split/upgrade or hard fork will be a taxable event if you end up with a larger asset total as a direct result.
In the case of the Bitcoin cash hard fork event, account owners woke up the next day with about $275 additional dollars in their accounts for every Bitcoin they owned. In all likelihood, the IRS will treat such activity as a taxable gain simply because you ended up with a larger asset.
Is there an upside?
Anyone who makes regular charitable contributions can turn a crypto asset account into a tax-free vehicle in some cases. For example, if your gain on Bitcoin was $5,000 (on an initial $1,000 investment) during the tax year, you could donate those now-appreciated Bitcoin assets to a charity and take the full $6,000 charitable deduction without having to worry about paying any capital gain.
You’ll need to be careful to donate your crypto assets directly to your favorite charitable organization; otherwise a capital gain tax will be triggered if you turn the crypto-currency into cash first. Timing is everything when it comes to donating your Bitcoin or other crypto assets to a worthy cause! And note that many charities are getting wise to this wrinkle in the law by accepting crypto-currency as donations on their websites.
What happens on April 15?
If your crypto-currency gains are huge in calendar year 2017, and then the so-called “Bitcoin bubble” bursts in early 2018, you might end up owing a significant amount of money on an April 2018 tax bill when you have very little hard cash to pay it with. This is almost an identical scenario as occurred when the dot-com crash took place in 2001. Lots of industry workers who had made out well from stock-option sales were left high-and-dry the following April when they had empty bank accounts and large tax bills.
If you’re up to reading some pretty dry, but informative data, the entire text of the new tax bill is here. The “tax FAQ” section from Coinbase’s own website is here. Finally, at IRS.gov, you can see what the government has to say about the finer points of reporting crypto-currency assets, here.
Please note that the above information is for educational purposes only and is in no way intended to be financial or legal advice. If you have questions about including crypto-currency in your portfolio, or how to handle what is already there, be sure to speak with a tax attorney in San Francisco.