Tax Law

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Statutes: Internal Revenue Code (26 U.S.C. §§ 1 - 9834).
Regulations: 26 C.F.R. ch. I
Regulatory Authority: Internal Revenue Service
(Also subject to state laws and regulations.)

Summary

Federal income taxes are owed on any realized gains in the value of cryptocurrency during 2018 upon the following events:
• Sale of cryptocurrency for cash.
• Purchase of goods and services with cryptocurrency.
• Exchange of one cryptocurrency for another cryptocurrency.

Ordinary income tax is also owed for the “fair market value” of any cryptocurrency that has been mined by the taxpayer. If the mining is done as a hobby activity, then the value of the cryptocurrency on the date of mining would be reported in the “other income” line of the taxpayer’s Form 1040.

IRS Guidance on Cryptocurrency

In March 2014, the IRS declared that "virtual currency," such as bitcoin and other cryptocurrency, will be taxed by the IRS as "property" and not currency. See IRS Notice 2014-21, Guidance on Virtual Currency (March 25, 2014). Consequently, every individual or business that owns cryptocurrency will generally need to, among other things, (i) keep detailed records of cryptocurrency purchases and sales, (ii) pay taxes on any gains that may have been made upon the sale of cryptocurrency for cash, (iii) pay taxes on any gains that may have been made upon the the purchase of a good or service with cryptocurrency, and (iv) pay taxes on the fair market value of any mined cryptocurrency, as of the date of receipt.

Date IRS Guidance on Virtual Currency
03/25/2014 IRS Guidance on Virtual Currency (Notice 2014-21) PDF
09/21/2016 Treasury Inspector General for Tax Administration - As the Use of Virtual Currencies In Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance (Ref. No. 2016-30-083) PDF
03/23/2018 IRS Reminds Taxpayers to Report Virtual Currency Transactions (IR-2018-71) PDF

Cryptocurrency Gains Reported on IRS Form 8949

For an individual filing a federal income tax return, the gains or losses from a sale of virtual currency that was held as a “capital asset” (i.e., for investment purposes) are reported on (i) Schedule D of IRS Form 1040 and (ii) IRS Form 8949 (Sales and Other Dispositions of Capital Assets). Any realized gains on virtual currency held for more than one year as a capital asset by an individual are subject to capital gains tax rates. Any realized gains on virtual currency held for one year or less as a capital asset by an individual are subject to ordinary income tax rates. The IRS requires, on Form 8949, for each virtual currency transaction, the following information be disclosed: (i) a description of the amount and type of virtual currency sold, (ii) the date acquired, (iii) date the virtual currency was sold, (iv) the amount of proceeds from the sale, (v) the cost (or other basis), and (vi) the amount of the gain or loss. It should be noted that the record keeping requirements of IRS Form 8949 can be particularly onerous for those who have used cryptocurrency to make numerous small purchases of goods or services throughout the year.

Date IRS Forms and Instructions - Tax Computation for Capital Assets in 2017 Form 1040
2017 IRS Instructions for Schedule D for Form 1040 PDF
2017 IRS Schedule D for Form 1040 PDF
2017 IRS Form 8949 - Sales and Other Dispositions of Capital Assets PDF
2016 IRS Publication 551 - Basis of Assets PDF

Prohibition on Tax-Deferral of Like Kind Exchanges

For transactions completed on or after January 1, 2018, the Internal Revenue Code now prohibits the use of Section 1031(a) for cryptocurrency transactions, and requires a taxpayer to recognize taxable gain or loss at the time that any cryptocurrency is converted into another cryptocurrency. Section 13303 of P.L. 115-97 (the tax act signed into law on December 22, 2017) changes Section 1031(a) to state as follows: “No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.”

For transactions completed on or prior to December 31, 2017, the IRS has not issued any guidance on whether different cryptocurrencies are "property of like kind" that would qualify for nonrecognition of gain under Section 1031(a). Generally speaking, exchanges between different cryptocurrencies are usually done by either (i) a simultaneous swap of one cryptocurrency for another or (ii) a deferred exchange, in which one cryptocurrency is sold for cash, followed by the purchase for cash, of a different cryptocurrency.

For transactions completed on or prior to December 31, 2017, Section 1031(a)(1) of the Internal Revenue Code states the following: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” In 26 C.F.R. 1.1031(a)-2(b), "like kind" is defined as follows: "As used in section 1031(a), the words like kind have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class." It should be noted that, in order to attempt to utilize the tax treatment of Section 1031(a) for transactions done on or prior to December 31, 2017, (i) each transaction must comply with certain requirements set forth in IRS regulations (such as the use, in certain instances, of a "qualified intermediary") and (ii) the taxpayer must file a Form 8824 with the IRS.

There is a risk that the IRS could use its prior revenue rulings on gold bullion as a basis for taking the position that, for transactions completed on or prior to December 31, 2017, different cryptocurrencies are not "property of like kind" under Section 1031(a). In Rev. Rul. 82-166 (October 4, 1982), the IRS ruled that an exchange of gold bullion for silver bullion does not qualify for nonrecognition of gain under Section 1031(a). The IRS stated: "Although the metals have some similar qualities and uses, silver and gold are intrinsically different metals and primarily are used in different ways. Silver is essentially an industrial commodity. Gold is primarily utilized as an investment in itself. An investment in one of the metals is fundamentally different from an investment in the other metal. Therefore, the silver bullion and the gold bullion are not property of like kind."

The IRS also stated in Rev. Rul. 79-143 (January 5, 1979) that an exchange of $20 U.S. gold numismatic-type coins and South African Krugerrand gold coins does not qualify for nonrecognition of gain under Section 1031(a). The IRS stated: "The bullion-type coins, unlike the numismatic-type coins, represent an investment in gold on world markets rather than in the coins themselves. Therefore, the bullion-type coins and the numismatic-type coins are not property of like kind."

On the other hand, the IRS did state in Rev. Rul. 82-96 (May 17, 1982) that a taxpayer's exchange of gold bullion for Canadian Maple Leaf gold coins qualifies for nonrecognition of gain under Section 1031(a). The IRS stated: "Because the Canadian Maple Leaf gold coins are bought and sold for their gold content, they are bullion-type coins. Therefore, the nature and character of the gold bullion and the Canadian Maple Leaf gold coins are the same, and they qualify as 'like kind' property as that term is used in section 1.1031(a)-1(b) of the regulations."

IRS Enforcement Actions

In 2016, the IRS issued a “John Doe Summons” to Coinbase, Inc., a licensed California bitcoin vendor and exchange, to obtain customer identity and transaction information about Coinbase’s customers. The IRS stated that, because only 802 individuals had reported capital gains or losses on sales of bitcoin in their 2015 tax returns, the IRS was conducting an investigation into the overall tax compliance of bitcoin customers. On July 6, 2017, after receiving objections as to the broadness of its customer information request, the IRS narrowed its Coinbase information request to information regarding accounts “with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013- 2015 period." On November 28, 2017, the court approved the narrowed IRS demand for Coinbase customer records.

Date IRS Enforcement Actions
12/05/2016 IRS Summons to Coinbase, Inc. for Customer Records - Original Record Request PDF
07/06/2017 IRS Summons to Coinbase, Inc. for Customer Records - Narrowed to Customers With $20,000 or More In Transaction Value PDF
11/28/2017 U.S. District Court N.D. Cal. - Approving IRS Demand for Records of Coinbase Customers With $20,000 or More in Transaction Value PDF

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