Bitcoin had an exciting 2017 to say the least, gaining almost 1,400 percent. Altcoins, a general term for all blockchain based tokens that are not Bitcoin experienced significant increases as well. Ripple was up nearly 40,000 percent. With all the attention given to cryptocurrencies due to their staggering appreciation, it’s time that to give the tax and information reporting side of cryptocurrencies a little attention too. 2018 has been a different story, but presently we will focus on implications for 2017 taxes.
Taxation of crypto transactions
Unfortunately, official guidance on cryptocurrency tax matters is virtually nonexistent. In 2014, the IRS released Notice 2014-21 which provided limited guidance in the form of frequently asked questions. The major takeaway was that “virtual currency” is property in the general sense and not a foreign currency. Therefore, receiving Bitcoin for services is taxable, gain on the sale of Bitcoin is taxable, and foreign exchange gain or loss does not have to be calculated. However, the Notice left many issues unanswered. For example, the Notice only applies to “convertible virtual currency” so how should tokens that do not try to be a currency be treated? It is clear that Bitcoin is a “convertible virtual currency,” and it is likely that Litecoin is too, but what about Ether or Ripple? Without additional guidance it is probably safe to assume that the Notice applies to all altcoins.
If Bitcoin and altcoin gains are taxable, how should income be calculated? Absent additional guidance the answer is easy, it’s the implementation that is hard. Generally speaking, gains should be calculated every time there is a transaction. Gain or loss is the price at the time of the transaction over the acquisition price. Transfers between wallets controlled by the same taxpayer are not likely taxable. The trick is that everything has to be calculated in US dollars, so the calculation gets difficult if Bitcoin is used to purchase Ether, which is converted into Salt, then sold back for Bitcoin. Do this on an exchange several times a week and your gain calculation quickly fills up a spreadsheet. Compounding the difficulty, several popular exchanges don’t provide the transaction history or details necessary to perform the calculations, or if they do it is not easily exportable.
Is there a shortcut? Absent guidance from the IRS, the answer is likely no. Mark-to-market rules would simplify the calculation because you would only need to compare the values at the beginning and end of the year. But, section 475 only makes the mark-to-market election available to “traders” of “securities.” Most crypto owners are not traders, they are likely investors, and cryptocurrencies would not likely qualify as a security for purposes of the election.
What about claiming like-kind exchange treatment? Again, not likely. Many on-line sources have circulated the rumor that, for 2017, cryptocurrency to cryptocurrency transactions can qualify for like-kind exchange treatment under section 1031. However, the requirements under section 1031 are very specific and claiming this exclusion still requires disclosure. This is not as simple as taking a like-kind position and excluding any income from your return; a specific form must be attached to your return with detailed disclosures about the transactions. Exchanges of gold for silver, or IBM stock for Apple stock, do not qualify under section 1031, so it is difficult to see how Bitcoin for Litecoin would meet the qualifications. Furthermore, when the exchange involves a third party, section 1031 requires the use of a qualified intermediary. Most cryptocurrency transactions occur on exchanges that do not meet the qualified intermediary requirements. Tax reform has changed section 1031 so that it only applies to real estate going forward; for 2018 and beyond there is no question that section 1031 does not apply to cryptocurrencies.
Information reporting obligations
Beyond taxation, the IRS is also charged with collecting certain financial disclosures. Simply holding cryptocurrencies in certain accounts can trigger foreign asset disclosure requirements. Specifically, we are concerned with Form 8938, Statement of Specified Foreign Financial Assets, and FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Penalties for the failure to file these forms starts at $10,000 and quickly escalates to over $100,000, or half of the account value if that is greater.
Generally speaking, Form 8938 is required when a U.S. person held more than $50,000 of assets at the end of the year, or more than $75,000 at any point during the year, in a foreign account. These limits are doubled for married individuals filing joint returns. Form 8938 is due with your annual tax return, including extensions. The FBAR generally applies to U.S. persons with foreign accounts with balances that exceeded, in aggregate, $10,000 at any point in the year. The FBAR is due Apr. 15, but that is automatically extended to Oct. 15 if you miss the first deadline. The FBAR filing requirement is separate from Form 8938, thus is it possible that both are required.
Absent official guidance to the contrary, and in light of the severity of potential penalties, it is reasonable to assume that both the FBAR and Form 8938 apply to cryptocurrencies held in foreign accounts. Having an account with Coinbase or Bittrex would not trigger these filing requirements because these exchanges are located in the U.S. However, common exchanges available to U.S. residents such as Binance, Bitstamp, and Bitfinex are based outside of the U.S. Deposits on these exchanges likely meet the technical requirements of both the FBAR and Form 8938. Therefore having held as little as a half of a Bitcoin on one of these exchanges could trigger a foreign asset reporting obligation for 2017.
Without additional guidance from the IRS, the taxation and information reporting requirements for cryptocurrency transactions can be very confusing. Hopefully the IRS will issue guidance soon to clarify and simplify the rules governing this new asset class. However, until such guidance is issued, those involved in cryptocurrency transactions should speak with their tax advisor to ensure they are in compliance with current guidance and to avoid substantial penalties.