The IRS sent out 10,000 tax letters this past week. They were “educational” letters, but also a shot across the bow. If you received one, there is a good chance that the IRS doesn’t think you’re properly reporting your crypto current gains and losses. If that’s the case, amend your prior returns. They’re on to you and they’re going to find you. It’s much better for you to come clean first before they catch you in audit.
Crypto currency is complicated and even the definition of what crypto even is doesn’t always make sense or is consistent.
In 2014, the IRS issued a definition that crypto would be considered a “property.” It’s not a currency. It’s not a security (like a stock). It is a property.
Okay, tax planners and crypto investor thought. That means we get to do like kind exchanges, just like property.
Not so fast, the IRS clarified that in 2018. You can NOT make tax free or tax deferred exchanges. They are taxable. So let’s stop there for a minute.
As a property and also as an investment, any expenses you have incurred would be considered investment expenses. Effective 1/1/2018 these are no longer deductible.
That means the expenses are not deductible and not even capitalizable, like you would do if you were developing real estate. (If the property was not yet put into service, rented, then the expenses you incur are capitalized to increase basis. And that means when you sell the property, you pay less capital gains tax.)
It’s not a security, so you don’t have “wash” rules. If you have a stock with a loss and feel the stock is going to recover, but you’d sure like to take advantage of the loss, there isn’t a lot you can do about it. You can’t sell the stock to realize the loss, and thus get a deduction, and buy the stock back so you’re ready to reap the benefits when it goes up in value. That’s called a “wash.” You have to stay out of the position for more than 30 days.
On the other hand, cryptocurrency is not a true investment. There is no wash rule. If you have some crypto that has gone down in value and you have some capital gains in a year, you can sell some of your position and then buy it immediately back. You take a tax loss and still have your position.
There are some other strategies for minimalizing your capital gains that I’ll be disclosing FOR THE FIRST TIME EVER in “Heads and Tales from the Crypto Currencies”, coming out early 2020.
If you sell or trade one type of crypto for another, that is a taxable event. Remember, there are no tax-advantaged exchanges allowed for crypto. But what if your crypto changes and becomes something else? That happens now and then. Your crypto is gone. Something new has taken its place. What now? Well, guess what even though it’s involuntary, it’s still taxable.
If your crypto launches a new version and gives you some of the new crypto as a bonus, that’s also taxable.
Now what if you use your crypto to buy a good or service. It’s taxable, even though that really doesn’t make sense. After all, if you use a debit card that is connected bank account to buy some gas that isn’t a taxable event. So why is using crypto taxable?
The IRS has been very clear on that point. Cryptocurrency is not a currency. Every time a crypto is used for payment of goods or services, you need to recognize this as if you sold the crypto. That means you have to keep track of every single crypto transaction, reporting the basis and date of purchase, reporting the value now and date of “sale”, and figure out the gain.
Forget about the confusion with knowing WHICH crypto you sold when you make that exchange, since the crypto in your online wallet undoubtedly has different bases. The IRS isn’t considering practical considerations in this tax law.
If I am spending some time in Europe and exchange some USD (US dollars) for EU currency, and while I’m there the EU goes up in value, score! It’s worth more when I use it to exchange. And it’s not taxable.
If the same event occurs with crypto currency, it is taxable when I exchange for goods and services.
That’s one of the many issues with crypto and the IRS. The tax position can be difficult.
Some members of Congress are aware of this issue. One solution that is being proposed is that Congress would simply declare that cryptocurrencies to be a means of exchange and remove the swapping of digital codes
The best policy solution to this rather odd tax problem is for Congress to simply declare cryptocurrencies to be a means of exchange and remove the swapping of digital coins from the many list of taxable events that the IRS watches.
This would require that Congress repeal IRS Notice 2014-21, the 2014 notice that stated that crypto was property.
Another possible plan, one that would be both very effective and have needed common sense has been introduced. It’s H.R. 3963, the “Virtual Value Tax Fairness Act.” This would permit crypto swaps to be included as a like kind exchange. Prior to 2018, like kind exchanges could be used for crypto. This would allow the tax-deferred rollover of property, just like with real estate.
If you own a rental property and want to sell it and invest again in another rental property, you can use the tax-deferred like kind exchange (also known as a Starker exchange or 1031 exchange). There are some strict rules, such as all cash from the sale can’t touch your hands and must roll over into the new property and you must buy something for as much as you sold the other property for. And, you have to do all of that within some tight time constraints. It’s not truly tax-free, because you roll over your old basis in the original asset. Eventually, you’ll have tax, unless you add another tax strategy for the exit. That requires additional planning.
Already we are seeing the results of the 2018 tax change, which meant that you can no longer take the tax-deferred option for exchanges. The American block chain and crypto companies will continue to move their companies offshore. They need to avoid the crippling tax burden and tax uncertainty that exists in the US. If you’ve moved to offshore crypto investments, remember you need to report the foreign assets when you file your tax return. That’s generally done with FinCen 114 (also known as FBAR) and is a separate filing, done online at www.FinCen.gov.
Who invests in crypto anyway? Is it just the rich, tech guys? No.
One third of all Americans are interested in investing in crypto, usually Bitcoin because it’s the best known. They don’t because they are afraid of what the IRS will do and there is a lot of uncertainty about what the tax issues will be. The typical investor makes less than $100,000 every year, has a family and lives in the suburbs. This is not a tax issue for a unique niche of American population.
If you currently own crypto, are you uncertain about how and when to file? Contact us! We can help, either through our current coaching class or with a personal consultation with me. We can also help you prepare the required tax returns. For more information, Contact Us.