Even the experts are confused by digital currency’s tax status
The last time the IRS answered questions about bitcoin was in a 2014 notice. Since then cyrptocurrency trading has exploded in size and complexity, raising new tax questions that have no easy answers. Here are some of them. Q: Does the 2014 notice apply to currencies that are not convertible into real currency? A: The notice said it applied to “convertible” virtual currency “that has an equivalent value in real currency, or that acts as a substitute for real currency.” It said one example is bitcoin, which can be exchanged for goods or services or “real” currency such as dollars and euros. There are now more than 2,000 virtual currencies, according to the CoinPuffs website. Many cannot be converted directly into dollars or other legal tender. You can buy a virtual currency such as bitcoin and exchange it for a nonconvertible currency, and do the opposite when you want to sell.
Although the IRS did not address nonconvertible currencies, most experts say they would be taxed like convertible ones.
“I would likely take the more conservative position that it would still be taxable,” said Erik Weinapple, tax director with accounting firm BPM. “Technically, you could convert any of the alternative coins to currency. It might take a couple of steps. but it’s still ‘convertible.’ Also, just about every alt coin you can purchase is likely exchanged somewhere, and that exchange provides you a price.” Q: I bought a cryptocurrency in 2009 and haven’t touched it. Do I have a tax liability? A: “If it’s just sitting there you have no taxable event,” said Masha Herzbrun, tax manager with Sensiba San Filippo. However, if you received additional coins through a fork or airdrop, you could owe tax on those coins. Sometimes cryptocurrency creators will give new coins to owners of existing coins through processes called forks and airdrops. An example is when bitcoin owners received bitcoin cash. Q: Are forks and airdrops taxable? A: Anytime you are given something for free, including through forks and airdrops, its value on the day received is generally taxable as ordinary
income.
If the coin has no value or can’t be traded immediately, “it’s not taxable until you can derive a value or start exchanging it,” Herzbrun said.
However, the IRS could “take a more aggressive stance and go back to the date of the fork transaction and tax you at whatever value it deems appropriate,” Weinapple said.
On the other hand, an investor could argue that a fork is not immediately taxable in the same way a stock split is not taxable until shares are sold, said San Francisco tax lawyer Robert Wood. Q: If I trade one virtual currency for another, is it taxable? A: Exchanging cryptocurrency for goods, services or real currency is clearly taxable. However, some investors who swapped a virtual currency in which they have a profit for another virtual currency had been deferring tax on the exchange, claiming that it qualifies under Section 1031 of the tax code. This section lets you postpone paying tax on gains when you sell business or investment property if you reinvest the proceeds in similar or “like kind” property. Some property, including stocks, bonds, inventory and your primary home, is specifically excluded.
The new federal tax overhaul limits Section 1031 exchanges to real estate starting in 2018, so cryptocurrency exchanges clearly will not qualify. Whether they qualified before this year
is debatable. Neither the IRS nor any courts have weighed in.
The Section 1031 rules “were not written when cryptocurrency was around,” said Weinapple. “Maybe you could argue it covers cryptocurrencies. To me it feels like it might be a stretch.”
Herzbrun said she would “determine it on a case-by-case basis. Coins are different in the way they function.”
Lisa Greene-Lewis, a CPA with TurboTax, said she thinks investors could qualify for a Section 1031 exchange if they swap one virtual currency for another, but clearly not if they swap a virtual currency for real estate or other property.
Wood said it would depend on “the timing and execution” of the swap. Investors who do this for 2017 should make sure they have good records and file Form 8824 with their tax return. Q: If I bought bitcoin at various times and sold a partial stake last year, how do I calculate my cost basis, and thus my profit or loss? A: With stocks and other marketable securities, you have several options. You can say the securities sold were the earliest ones acquired (first-in-firstout), the last ones acquired (last-in-first-out), ones purchased on a specific date, or you can use an average cost. Those rules also apply to inventory, Herzbrun said.
The IRS has never said whether these options apply to virtual currency. When there is no guidance, Herzbrun said, it’s
best to take the conservative approach, and that is usually first-in-first-out. When prices are rising, it generally results in the biggest tax, although it could benefit the taxpayer if it converts a short-term gain into a long-term one.
Wienapple, on the other hand, said he thinks investors should have the same options with cryptocurrency that they have with stock.
Wood said there are arguments to made on both sides. Whatever method they choose, investors should use it consistently and keep good records. Q: I bought virtual currency that was stolen by hackers. Can I deduct it as a theft loss? A: Before tax year 2018, you could deduct unreimbursed theft losses as an itemized deduction, but only the portion that exceeded 10 percent of adjusted gross income. Starting this year, theft losses are no longer deductible.
If you lost cryptocurrency because of theft (not because the value fell) in 2017, you may be eligible for a deduction if it’s large enough. “You have to prove it was a sudden and unexpected loss. Part of the problem is proving how you got the money there,” said Peter Rehm, a nonpracticing CPA who writes about cryptocurrency taxes.