Cryptocurrency (Bitcoins & Taxes)

For 2013-2016 Tax Years less than 1,000 individuals reported cryptocurrency transactions. But, with the explosion of Bitcoin from less than $500 to $20,000 in 2017, Uncle Sam will be knocking at your door for a piece of the pie.

Last November a federal court in San Francisco ruled that Coinbase must comply with IRS summons to provide information about individuals who bought, sold, sent, or received at least $20,000 worth of Bitcoin. You do not have to worry about anything if you only bought and held your tokens.

The IRS has provided little guidance on this but for the IRS Notice 2014-21. Many of the experts think Cryptocurrency gains and losses should be treated as long-term or short-term capital gains/losses or ordinary income/loss. The classification is subject to the acquisition method. For instance if you are a passive investor, gains or losses are long-term or short-term. If you are a crypto miner or receive compensation in lieu of cash for service rendered, the compensation is ordinary income. Short-term capital gain rates are based on your regular income tax bracket, while the long-term capital gains rate is 15-20%.

A friend of mine posited that you could Use a §1031 Exchange to Defer Gain with Cryptocurrency. Is he right? No he is not.

First let’s take a look at the §1031 Exchange definition - A §1031 exchange is a way of deferring the capital gain on a property by exchanging it for another property. In layman terms: You bought a Condo and you sold and replaced it with another Real Estate Property – You do not have to pay taxes on any of the gain(s) if you meet the requirements. This is one of the best ways Real Estate Investors defer paying taxes on their gains.

Here is an excerpt of the statutory language of §1031:

26 U.S. Code §1031 – Exchange of Property Held for Productive Use or Investment

(a) Nonrecognition of Gain or Loss from Exchanges Solely In Kind

(1) In General 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.

But that wasn’t all of 26 U.S. Code §1031. There is property that is not eligible for like-kind treatment. Let’s no look at §26 USC 1031(a)(2):

(2) Exception This subsection shall not apply to any exchange of—

(A) stock in trade or other property held primarily for sale,

(B) stocks, bonds, or notes,

(C) other securities or evidences of indebtedness or interest,

(D) interest in a partnership,

(E) certificates of trust or beneficial interests, or

(F) choses in action.

Although, the IRS rule that cryptocurrency is property in IRS Notice 2014-21 - The closest similarity to how cryptocurrency should be treated are stocks and bonds. And §26 USC (a)(2)(B) states that you can’t do a §1031 exchange for stocks and bonds.

Mat Sorensen did an excellent job covering the taxability of cryptocurrencies in this article below.

"Tax Planning for Bitcoin and Other Cryptocurrency Profits"

Clayton Financial & Tax purported:

“This is not going to be the last effort by the IRS, either. There are other US-based exchanges, and the IRS will likely be calling on them. Additionally, I expect Congress eventually to mandate reporting of cryptocurrency transactions (or the IRS to issue regulations attempting to require such reporting). If you’re an American who used Coinbase and left out some cryptocurrency sales, now is a good time to amend your tax returns.”

The reporting on this won’t be easy because some of the exchanges are international. For, If “Aggregate value of international financial accounts exceeds $10,000 at any time during the calendar year. You are required to report it on your federal tax return.” Additionally, you are required to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).

At this point, we will not even go into the wash-sales provision because of the complexity of this new beast. For most of you, your gain will be short-term. We encourage people who transacted $20,000 or more in cryptocurrencies to find a CPA with experience in trading to help analyze your situation. Voluntary disclosure is a good self-preservation strategy when it comes to IRS. You are probably giggling after reading this last sentence because most of us practice “Don’t ask, Don’t tell.”


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