On December 20, Senate Republicans passed the Tax Cuts and Jobs Act of 2017, voting 51-48 to support a reconciled version of the bill which merged proposals from both chambers of Congress. The bill, controversial from inception due to its host of sweeping reform provisions, was signed into law by President Donald Trump on December 22, becoming Pub. L. (Public Law) 115-97. Since the bill was touted as one of the most comprehensive tax reform packages in decades, it’s unsurprising that the law impacts tax brackets, the standard deduction, the mortgage interest deduction, the Child Tax Credit, the alternative minimum tax (AMT), and other familiar features of the Internal Revenue Code. However, there isone surprise taxpayers may not have anticipated: changes to the way cryptocurrency traders are taxed. If you currently trade or recently traded virtual currencies, such as Bitcoin and Ether, your tax liabilities may be increasing. Before you file your 2017 tax return, make sure you have guidance from an experienced Bitcoin tax attorney who can help you navigate the new tax laws safely.
Under New Tax Law, Digital Currency Trades Do Not Qualify for 1031 (“Like-Kind”) Exchanges
If you trade different virtual currencies, be on high alert: the following information could directly impact you. The GOP tax law – the full text of which can be perused here – contains provisions that may increase tax liabilities for cryptocurrency traders by removing the possibility of deferring (delaying) taxes in trade scenarios where the currency’s value increased. For the cryptocurrency-savvy, this should immediately bring to mind dominant virtual currency Bitcoin, whose value ballooned more than tenfold over the past 12 months, rising from approximately $1,000 in January 2017 to approximately $11,150 as of January 2018. (This increase, while impressive, actually marks a dramatic decline from Bitcoin’s peak value of $19,783 on December 17; but speculation on the ultimate fate of the Bitcoin bubble is a topic for another day.)
In the past, investors arguably had the ability to defer taxes when exchanging cryptocurrencies, such as Bitcoin, Litecoin, Zcash, Dash, or Ether, for one another (though, as we will discuss shortly, this was never made explicitly clear by the Internal Revenue Service). However, with various bureaus of the Treasury Department, including the IRS and Financial Crimes Enforcement Network (FinCEN), steadily tightening cryptocurrency regulations – an ongoing process our cryptocurrency tax attorneys have discussed in prior articles here, here, and here – the new tax law is following suit, imposing tougher restrictions on like-kind or “1031” exchanges, a term derived from the applicable tax statute, 26 U.S. Code § 1031 (exchange of property held for productive use or investment).
Before the passage of Pub. L. 115-97, like-kind exchanges applied to “property held for productive use in a trade or business or for investment” in accordance with 26 U.S. Code § 1031(a)(1). However, the new law narrows “property” to “real property,” with Section 13303 of the law providing that “Section 1031(a)(1) is amended by striking ‘property’ each place it appears and inserting ‘real property.’”
Though the IRS never issued particularly specific guidelines on the subject, digital currency exchanges were nonetheless sometimes treated as like-kind exchanges, which are not taxable events, prior to the tax reforms. As our California tax attorneys wrote in a prior tax law article, “Since no guidance on this subject currently exists, 1031 exchanges of differing types of cryptocurrency, while not outright prohibited, is not guaranteed to be a tax-free exchange.” While we initially suggested that taxpayers could potentially “claim the benefits of 1031 during this type of an exchange,” we later retracted our position, noting that “taxpayer[s] exchanging Euros for U.S. Dollars would not be able to rely on Section 1031 to defer any currency exchange gain and so it appears that the same could be said about exchanging one type of virtual currency for another.”
While this issue was somewhat open to debate before the bill’s passage, the tax reforms bring greater clarity to the subject. As one tax attorney told Bloomberg BNA, “If I want to stay invested in cryptocurrencies, I would be able to change from bitcoin to ether and not have to pay tax until the end when I exit the crypto market. Now, that’s not going to be possible.”
Cryptocurrency users are required to report income, foreign income, and capital gains from Bitcoin and other virtual currencies and may also be required to file an FBAR. Thus, if a taxpayer realizes capital gains by trading one currency for another, he or she will be required to pay taxes on those gains, though different tax rates will apply depending on how long the asset – meaning, in this case, the cryptocurrency – was held. Short-term capital gains are generally taxed like income, while long-term capital gains, meaning assets held for over one year, are taxed at a lower rate: 0%, 15%, 20% or 23.8%, depending on tax brackets.
Bitcoin Tax Lawyers Offering Cryptocurrency Consultations for Individuals and Businesses
The regulations governing cryptocurrency are not only complex – they are also in a constant state of change, with the new tax law creating even more confusion for digital currency traders, buyers, sellers, miners, and investors. If you trade, sell, purchase, or otherwise use Bitcoin or other cryptocurrencies, whether to pay your employees, save for retirement, or for other purposes, you are advised to review your record of compliance with an experienced tax attorney who will approach your matter with precise, up-to-date knowledge of the complicated laws surrounding like-kind exchanges, capital gains taxes on Bitcoin, and other cryptocurrency tax issues. To arrange a reduced-rate consultation with our zealous tax lawyers, CPAs, and EAs, contact the Tax Law Office of David W. Klasing online, or call today at (800) 681-1295.
Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices in San Bernardino, Santa Barbara, Panorama City, and Oxnard! You can find information on all of our offices here.
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