2nd Chamber: IRS Treatment Of Cryptocurrency
Why the series title? I’m a huge Wu Tang Clan fan. Their first album was named Enter the Wu-Tang (36 Chambers). This album changed my life and hip hop forever. It is my goal to change the way complex tax and business issues can be explained to the masses.
Pop Quiz: What is cryptocurrency?
Cryptocurrency is a digital currency that uses encryption techniques, rather than a central bank, to generate, exchange, and transfer units of currency. Unlike cash transactions, no bank or government authority verifies the transfer of funds. Instead, these virtual transactions are recorded in a digitized public ledger called a “blockchain.” Individual units of the currency are called “coins.”
So when you see me on your block with two Glocks
Screaming “F*** the world” like Tupac
I just don’t give a f***
Talking that shit behind my back
Dirty macking, telling your boys that I’m on crack
I just don’t give a f***
-Eminem, Just Don’t Give a F****
I must admit that when I’m in a “me against the world” mood, this song always pops in my head. Also, this song comes into my mind when I think how taxpayers felt about reporting their cryptocurrencies on their tax returns. Most taxpayers thought, “there is no way that the IRS can find my identity.” Then the IRS addressed the taxation of cryptocurrency transactions in Notice 2014–21 back in 2014, which provides that cryptocurrency is treated as property for federal tax purposes and people’s tune started to slowly change. Keep in mind that the guidance on the Notice 2014–21 may change soon but for right now it should be viewed as a starting point on the IRS views on cryptocurrency taxes. There is no excuse for a lack of knowledge.
In Notice 2014–21, we learned that the general tax principles that apply to property transactions must be applied to exchanges of cryptocurrencies as well. Taxes are complex but cryptocurrency taxes are insanely complex. To learn about how property transactions are applied, I highly recommend visiting www.irs.gov. Most taxpayers are intimidated when I make this recommendation but the IRS website is very easy to read and understand. Start with Publication 544 which can be found at https://www.irs.gov/publications/p544. Now, if you are like myself and have a short attention span, just pay a tax consultant to go over the basics with you.
Notice 2014–21 holds that taxpayers must recognize gain or loss on the exchange of cryptocurrency for cash or for other property. This is where the beautiful world of “cost basis” comes into play. Cost basis is the original value of an asset for tax purposes, usually the purchase price. This value is used to determine the capital gain, which is equal to the difference between the asset’s cost basis and the current market value. When filing your tax returns, it is very important to be able to determine how you got the cost basis of the cryptocurrency. Use the same method for every reportable cryptocurrency tax transaction. All jokes aside, please don’t complete your cryptocurrency taxes without a tax accountant.
Gain or loss is recognized every time that cryptocurrency is sold or used to purchase goods or services. Okay, the sale of cryptocurrency being taxable was expected. However, I bet learning that using your cryptocurrency to purchase goods or services is a taxable transaction that probably ruined your day! Before you use your bitcoins take someone on a first date, make sure that the person is going to be your future spouse. Imagine spending bitcoins to take someone out on a blind date, it didn’t work out and to make matters worse, you get a letter from the IRS about not filing it on your tax returns. I’m not telling you how to spend your cryptocurrencies. I just want you to know to really think about the purchase before doing it. Also, don’t try to act like you are smarter than the IRS. Report all possible cryptocurrency tax transactions on your annual tax returns.
How the gain or loss is recognized depends largely on the type of transaction conducted and the length of time the position was held. For example, to have a sale of cryptocurrency treated as a capital gain or loss then you must have held it over a year and one day. This is another reason why keeping great records are so important. Most taxpayers can’t afford to purchase one whole bitcoin. Therefore, they purchase many small portions of a bitcoin. Keeping track of all the transactions can be a headache. There are several websites that can help you keep track to make the process more manageable during tax season time. I promise you that I will write several articles about different websites.
The Notice 2014–21 isn’t perfect and doesn’t answer all the burning cryptocurrency tax questions. The IRS’s guidance in Notice 2014–21 clarifies various aspects of the tax treatment of cryptocurrency transactions, but many questions remain unanswered, such as how cryptocurrencies should be treated for international tax reporting [e.g., Report of Foreign Bank and Financial Accounts (FBAR) & Foreign Accounts and Tax Compliance Act (FATCA) reporting] and whether cryptocurrency trades prior to 2018 are subject to the like-kind exchange rules. Hopefully, the IRS will clear these issues up in their next major Notice regarding cryptocurrency taxes.
Until next time……Blockchain 4 The People!!!!!
Need help with your crypto taxes? Contact me at jamaal@jstaxcorp.com
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