“Ask The Taxman”, Is Cryptocurrency Taxable? Myths Debunked!
In the world of cryptocurrency, there are many myths floating around about taxes that simply are not true. We discuss them below.
Myth Number 1
Many people believe that cryptocurrency gains or losses are not taxable if they were incurred on to an exchange between two different currencies. The IRS treat currency trading, also known as Forex Trading as a taxable event requiring reporting.
The truth is that every time a cryptocurrency is sold, whether it is exchanged for another cryptocurrency or for fiat money, the transaction must be reported, and the loss or gain calculated for tax reporting purposes. More importantly, you must have a way of tracking the basis of the currency. I would highly encourage you to seek our one of the Cryptocurrency tracking and reporting platforms to help with the tracking and reporting of your activities. Not doing so could create a monumental task, especially if you make a lot of cryptocurrency purchases.
Many people are under the mistaken impression that exchanges prior to January 1st of 2018 are not reportable. I think the confusion was caused by the tax law the President signed in December of 2017. The new tax law stipulates that like-kind exchanges under section 1031 only applies to real property starting on January 1, 2018. But, neither the old tax law nor the new tax law ever treated cryptocurrency as like kind “property”. Only specific property qualifies for like kind and cryptocurrency does not qualify.
Myth Number 2
If cryptocurrency is stored on an exchange or in a cryptocurrency wallet, but is not sold and exchanged for fiat money, it is not a taxable event. But, the IRS explained in Notice 2014-21 that any cryptocurrency received as payment must be reported at its fair market value in dollars on the date it was received. This amount becomes the basis for calculations of gains or losses in the future.
Myth Number 3
One of the ways that new cryptocurrency enters circulation is by mining. But did you know that cryptocurrency received this way is subject to taxes? The IRS made it clear in Notice 2014-21 § 4 A-8 that a taxpayer must include in their gross income the fair market value of mined cryptocurrency. Fair market value is calculated on the date it is received – for example, the date a mining pool pays out to the taxpayer. If the miner is running a business for mining, they may also be required to pay self-employment taxes and report that business on a Schedule C if a sole proprietor.
Myth Number 4
Much confusion has arisen around whether cryptocurrency is actually currency, or whether it is property. While the cryptocurrency community may disagree, the IRS considers it to be property. See the IRS’ guidance. So, any type of exchange of cryptocurrency for anything else – whether a good, service, or another cryptocurrency – triggers a tax event. Using cryptocurrency to pay an employee, or to purchase a coffee, requires the taxpayer to calculate and report the gain or the loss. This is calculated as the difference of the value in dollars on the transaction date and the cost basis of the cryptocurrency.
Myth Number 5
One factor in the proliferation of cryptocurrencies is hard forks. There are several types of forks, but primarily hard forks and soft forks. A hard fork is a spitting of the currency, much like a stock split. It just divides the basis into smaller pieces, but it is still a reportable taxable event when exchanged, that now requires more sophisticated tracking. A soft fork is a temporary divergence in the block chain caused by non-upgraded nodes now following new consensus rules. There are other types of forks but does not change the fact that this is a taxable event. The taxpayer has acquired a new cryptocurrency due to the hard fork, so it is the same as having acquired any other cryptocurrency by any other method. This is an area where the IRS has not yet issued any guidance. Tax professionals are usually taking one of two approaches:
- Assign the cryptocurrency acquired due to the hard fork a zero-cost basis.
- Recognize income received at the fair market value in dollars as of the time the coin was received
Most experts believe that when the IRS does issue guidance in this area that they will require the second approach, since the first approach allows the deferment of taxes until the coin is sold.
In Summary
Cryptocurrencies are new, and although the IRS has been issuing some guidance, there are still many unknowns. Until all of the issues are clarified, it is important for the US taxpayer to be aware of the guidance that has been issued and make every effort to comply.