The Internal Revenue Service (IRS) has been cracking down on taxpayers for failure to report cryptocurrency transactions. At the end of 2017, it succeeded in its nearly two-year efforts to order Coinbase, Inc. to produce taxpayer information on unreported transactions.
As such, it is important to keep Uncle Sam in mind when it comes to the recently increased popularity of cryptocurrency and resulting transactions.
In 2014, the IRS issued guidance (Notice 2014-21) (”IRS Notice”) on cryptocurrency, making it clear that for tax purposes, it is treated like property. The IRS Notice holds that taxpayers must recognize gain or loss on the exchange of cryptocurrency for other property. This means that cryptocurrency can be treated as business property, investment property, or personal property.
For investment purposes, gains and losses are computed in the same manner as stock investments. For those who exchange cryptocurrency directly for goods, services, or other cryptocurrencies, the individual transactions may result in a gain or a loss.
Although the IRS may not have tracked down every single U.S. taxpayer who has used cryptocurrency, it is important for taxpayers to proper records.
In determining the U.S., income tax consequences, the starting point is the cost basis; generally, the cost basis is what was paid for the cryptocurrency. Adjustments can be made to the cost basis if there are related costs, such as fees paid to acquire the asset. For 2017, any investment related fees may be deductible on Schedule A if the taxpayer owns the cryptocurrency personally and itemizes deductions. Otherwise, if the taxpayer’s entity owns the asset, then the investment related fees may be deducted on either Schedule C or the entity’s tax return, depending on the business structure.
The taxable event is generally a sale or disposition of an asset. When it comes to cryptocurrency, a taxable event occurs when it is traded for cash, other property, or used to purchase services. This does not mean tax will be owed but it does mean that tracking each transaction is imperative to substantiate gains or losses.
Finally, the character of gain or loss depends on whether the cryptocurrency is a capital asset in the taxpayer’s hands. Cryptocurrency held as an investment may be considered a capital asset. A long-term (held more than one year) capital gain is eligible for the preferential tax rates which are 0%, 15% or 20%, depending on the tax bracket, not including the Medicare surtax. Short-term capital gains, held less than a year, are taxed as ordinary income.
Taxpayers should report their gains and losses and certainly, shouldn’t rely on exchanges, such as Coinbase, Inc., to keep track of their activities. We recommend creating a reliable record-keeping system that identifies the cost-basis method and exchange rate. Individual record keeping is imperative once Uncle Sam comes knocking on your door.
Should you have any questions or desire further insight, feel free to contact one of the members of our Tax Department:
DISCLAIMER: This article is not intended to provide legal advice, and no legal or business decision should be made based on its contents.