How the IRS IS Going To Tax Your Bitcoin (or other cryptocurrency) Profits

Every time you log on to the internet these days, you see an article that says “Bitcoin reaches new highs” “Ethereum up 3000% in a year” “ICO has record setting day” “Cryptocurrency reaches 100 billion market cap” and so on, and so on. This is obviously great for the future of cryptocurrency, but with the good comes the bad. I guarantee you; there is a group with the IRS trying to figure out how to tax your profits.

I consider these statements to be myths and should not be listened to:

• It’s not taxable because I didn’t get a W2 or 1099
• It’s not taxable until it is converted to cash
• It’s not taxable because it wasn’t earned in the United States
• Only certain kinds of cryptocurrency are taxable
• It’s not taxable because the IRS cannot track it

Here is what I believe the IRS would tell you if you asked the following questions:

1. Currency or Property?: ------ For federal tax purposes, it is property. So think of buying a Bitcoin to be the same as buying 100 shares of stock in Microsoft.

2. Report Gain or Loss on every transaction? ------- Yes, this is where it gets scary because I don’t think many investors are tracking correctly. Let’s say you buy 1 Bitcoin on an exchange using $2500. The bitcoin sits on exchange for 5 days and the value increases to $3000. Instead of converting to cash, you exchange your 1 bitcoin for 10 Ethereum. No big deal right? Wrong, you now have $500 in income to report to the IRS. The next week the value of Ethereum decreases from a USD value of $3000 to $2000. Can you use that loss to offset your $500 gain? Yes, but only if you sell or exchange for something else. Think of exchanging cryptocurrency as buying a stock and selling that stock to buy a new stock

3. What about “mining” or “harvesting”? ------ Yes, these would be taxable events. I did some “harvesting” and got the equivalent of $6. The IRS would expect me to report that $6 as income.

4. Can I deduct any expenses? -------- For an average investor I would say no. It would be like trying to expense your laptop if you were using it to invest in the stock market. If you’re a miner and treating that activity as your trade or business, then yes. Be careful though, this may trigger self-employment income.

5. What if I receive Cryptocurrency in exchange for services? ---------- Taxable based on the USD value when received.

6. What if I pay someone for services in Cryptocurrency? -------- You may have gain/loss depending on what you acquired the Cryptocurrency for. Also, you have to issue that person a 1099 and report to the IRS.

7. Do I only report Cryptocurrency that is earned in the United States? --------- No, the IRS taxes your worldwide income.

8. Is only Cryptocurrency taxable?, What about tokens? -------- All would be taxable. There are 700+ cryptocurrencies, altcoins, tokens, etc.

9. Are there any foreign issues, I should be worried about? -------- Yes, foreign bank account reporting (FBAR) may be required. There also may be requirements under the Foreign Account Tax Compliance Act (FATCA).

10. What is the worst that could happen? --------- Most likely there would be tax, penalties and interest for not reporting correctly. If the IRS thought someone was intentionally trying to avoid tax, then tax evasion charges could be filed.

11. How will the IRS catch me if I’m not reporting? ------ That’s the question the IRS is trying to figure out. Here are some potential ways:

    i) Say you were audited and an auditor asked for your banking detail. If you acquired cryptocurrency for cash or redeemed for cash, an auditor would discover some transactions.

    ii) The IRS gets exchanges to turn over their records. This is already happening with Coinbase. In November of 2016, The Department of Justice filed an initial request, on behalf of the IRS, to get Coinbase to turn over all United States Customers who transferred cryptocurrency.

    iii) The Cryptocurrency market becomes more regulated and 1099s start to become issued.

I decided to post this article because I don’t think a lot of investors are considering the tax consequences of buying and selling cryptocurrency. Proper record keeping will be essential. I’m definitely not pro-tax and I may not agree with the position of IRS, but that’s the world we live in. Please do your own research and make sure you are comfortable with the tax positions you are taking. I think this an area that is going to evolve quickly. I wouldn’t be surprised if the IRS releases additional guidance. I also think the IRS would like make an example out of any early audits, where noncompliance is discovered.

Good Luck Trading!