Archive for the ‘Cryptocurrencies’ Category

Taxes When a Cryptocurrency Splits Into Two

Monday, August 21st, 2017

The IRS ruled that cryptocurrencies are treated as property (like stocks and bonds). What happens when a cryptocurrency splits into two separate cryptocurrencies?

Let’s start with the analogous situation with a stock. Suppose Acme Industries, Inc. spins off its subsidiary, SubCo Inc.; on October 1st stockholders of record will receive one share of SubCo for every share of Acme they own. This is almost certainly a tax-free event. (For those who care, Internal Revenue Code (IRC) Section 355 governs corporate spinoffs. Tax-free spinoffs can be accomplished either by distributing shares based on current ownership or by giving shareholders the option to exchange shares for the new spun off entity.)

Now, let’s examine a cryptocurrency split. Let’s take HYPO, a hypothetical cryptocurrency. On October 1st everyone who has 1 HYPO will still have their HYPO but will also now own 1 THET. The published goal is so that more transactions can be run through the blockchain. Will this be a tax-free event?

Probably. IRC Section 355 doesn’t apply here; this is not a corporate spin-off. That said, the analogy should hold: Presumably nothing of value has been created. If HYPO was selling for $1,000 prior to the split, the sum of 1 HYPO and 1 THET should be worth the same $1,000 after the split. If that’s the case all that’s happened is that your basis in HYPO must be split into HYPO and THET. For example, if you purchased your 1 HYPO for $500, your basis post-split in HYPO and THET must add to the same $500. There wouldn’t be a capital gain based on the split. (The allocation should be based on the fair market value of HYPO and THET immediately after the split.)

One other question that must be answered: Do you obtain the same holding period for the spin-off as you had for the original cyrptocurrency? If it’s a true split into two cryptocurrencies, definitely.

Given there has been one cryptocurrency split already (and others will certainly follow) this will give you an idea of the basics in this situation. Something that absolutely holds is keep good records! Taxes when you have good records is fairly easy. When you don’t have good records, it’s definitely not.

On Tulips and Bitcoins

Sunday, August 20th, 2017

When I was in junior high school, I remember being taught about the 17th century tulip mania. Tulips in 1637 cost more than a house! That was a bubble (though some economists think there may have been rational explanations, let’s just call it with what it was considered to be), and my gut feeling is that cryptocurrencies are also bubbling.

I’m not the only person who has made this comparison. There’s an article on CNBC that quotes Elliott Prechter stating that cryptocurrencies are in a bubble comparable to tulips. The head of the Dutch Central Bank has also made the same comparison.

But there’s something else with cryptocurrencies: government. While the US government hasn’t formally stated that it wants cryptocurrencies to go away, the policies of the Department of the Treasury and the Department of Justice show that’s the case.

Let’s look at what two agencies within the Department of the Treasury have done in regards to cyrptocurrencies. First, the Internal Revenue Service had a choice: Should cryptocurrencies be considered currencies or should they be considered property? If currencies, most taxpayers would just enter one number on their returns for the gain (or loss). (Currency trading falls under Section 988 of the Internal Revenue Code. Gains and losses are simply entered as Section 988 transactions as part of line 21 (“Other Income”) on Form 1040.) This would be simple and straightforward. Instead, the IRS ruled that cryptocurrencies should be treated as property. That means each time you use or sell a cryptocurrency you have a reportable capital gain or loss. That’s a much tougher recordkeeping requirement.

Meanwhile, the Financial Crimes Enforcement Network (FINCEN) ruled exactly the opposite. For FINCEN purposes, cryptocurrencies are currencies, not property. That means cryptocurrencies fall under the purview of FINCEN. If you are an active seller of cryptocurrencies to others, you may have to register and are subject to the money transmittal rules. (FINCEN has said “miners” and investors of cryptocurrency are not money transmitters.) FINCEN has gone after foreign (non-US) based wallets, too.

The US Department of Justice has prosecuted US individuals who have been selling Bitcoins.

Perhaps I’m cynical (well, I know I am), but it appears to me that the US government’s actions are designed to make cyrptocurrencies appear more unattractive. That to me is more likely than not to put downward pressure on cryptocurrencies.

I should point out that friends of mine who are far smarter than I am think that Bitcoins will be worth $10,000 in the near future (as I write this, the price of a Bitcoin is about $4,100). I don’t see that. I was in the dot-com industry when that was booming and the NASDAQ would “obviously” reach 100,000. Then the bottom fell out. The cryptocurrency craze of today reminds me of that and of tulips.

Did I Prepare 5% of the Tax Returns with Bitcoin in 2015?

Sunday, August 13th, 2017

The IRS is attempting to force Coinbase to disgorge a list of its customers who have traded Bitcoins. Back in March, an IRS agent, as part of attempting to enforce its summons against Coinbase, stated that there were only 802 individuals who reported Bitcoin transactions on Form 8949. The IRS searched and that’s what they supposedly found after looking at over 120 million returns filed for 2015.

My records show that I filed 40 returns in 2015 with Bitcoin transactions. According to the IRS that means I prepared 5% of all returns with Bitcoin transactions on them for tax year 2015!

Let’s be honest: There were more than 802 individuals who had Bitcoin transactions in 2015. This is why I expect (in the long run) the IRS’s summons against Coinbase will be successful.

This also may say something about tax professionals (and not a good thing). Now, it is true that my clientele happens to be more likely to skew towards individuals owning cryptocurrencies such as Bitcoin. Still, am I one of the few tax professionals to ask clients about cryptocurrency transactions?

It’s actually far more likely that most tax professionals have a Sergeant Schultz moment with Bitcoins: Since there’s no paperwork, there’s nothing to report. That’s not how it works: Income is taxable (or not) regardless of whether or not you receive paperwork. For example, if you do consulting work for someone and get paid $800 but you don’t receive a Form 1099-MISC noting the income, you must report that $800. Individuals who self-prepare returns likely have the same issue: No paperwork, no reporting.

Cryptocurrency is fertile ground for the IRS, and sooner or later the IRS is going to get this information and conduct audits on it. If you are trading Bitcoins or other cryptocurrencies, you need to report them on your tax return. And if you’re a tax professional, you need to ask clients about this.

Exchanging One Cryptocurrency for Another Is a Taxable Event

Saturday, May 27th, 2017

Let’s assume I own some Bitcoins and you own some Ethereum; these are two cryptocurrencies. We think they’re each worth $5,000 and we agree to swap them. Do we have a taxable event?

The IRS consideres cryptocurrencies to be akin to stocks and bonds. That means any time I sell or otherwise dispose of cryptocurrency I have a realized capital gain or loss. A client was told by a cryptocurrency trader that exchanging one cryptocurrency for another is not a taxable event. That individual is mistaken.

Let’s look at an analogous situation: You and I each own $5,000 worth of a stock (say General Motors and Ford). We swap stocks. I no longer own Ford, so I have a gain (or loss) on my Ford stock; you have a gain or loss on your General Motors stock. No one can successfully argue that this swap doesn’t result in a taxable event for each of us.

As I said swapping one cryptocurrency for another is analogous. Is a Bitcoin identical to an Ethereum? No; they’re each different cryptocurrencies. If you sell or dispose of a cryptocurrency, you have a taxable event. It’s very clear that such swaps absolutely must be reported on Schedule D.