If you’ve got Bitcoin or other cryptocurrencies, you’ve got a unique set of tax issues. Don’t ignore them or approach them like you would the rest of your tax situation. Instead, get education on what the tax law for cryptocurrency and Bitcoin looks like. Remember, the IRS will not accept your failure to know or understand the law as an excuse.
Reporting Cryptocurrency on Your Taxes
Bitcoin and other cryptocurrency users must report all income, both foreign and domestic, from all digital currencies. Bitcoin and cryptocurrency users may also need to file a “Foreign Bank Account Report” or FBAR. Since the IRS expects you to report all income, whether it’s digital or not, this leads to a few other issues.
When you sell or exchange virtual currencies, taxable gains are generated even where no cash was received in the transaction. How much taxes you must pay on those gains is determined by how long you hold the cryptocurrency and generally is taxed at increasingly higher tax rates based on the amount of total adjusted gross income you earned for the tax year at issue.
If the sold or exchanged cryptocurrency was not held for at least a year before it was exchanged short-term capital gains result that are taxed as “ordinary income” at graduated tax rates as high as 39.6% (i.e. not at preferential capital gains rates) On the other hand, when you sell, or exchange cryptocurrency held for a year or longer, long-term capital gains result. Long-term capital gains are taxed at preferentially lower capital gains rates as high as 23.8%.
Identifying Cryptocurrency Users
The IRS is working overtime to identify people using cryptocurrencies. To identify users, the agency cooperates with blockchain businesses such as Chainanalysis, a blockchain advisor. Chainanalysis parses cryptocurrency transactions with pattern recognition, open source references, and machine learning to identify suspicious activity.
As always, the IRS is searching for hidden income, and any illicit transactions that might be producing it—things like drug sales and money laundering. The IRS knows about “mixers,” also known as “tumblers,” which blend funds to hide their origin. In the end, Bitcoin and other cryptocurrency mixers can delay or complicate IRS investigations, but they can’t stop the agency from finding what they’re looking for.
In May, the IRS rolled out new laws targeting virtual currency exchanges such as Coinbase. Part of the impetus for this change was to prioritize cryptocurrency tax compliance by identifying individual users. Who faces the highest risk for audits or criminal tax investigations? Users with unreported Bitcoin or other cryptocurrency transactions in excess of $20,000.
Cryptocurrency and 1031 Exchanges
Although there was some gray area here in the past, the recent Tax Cuts and Jobs Act ensures that Bitcoin does not qualify for like-kind exchange under Section 1031. Now, Section 1031 applies only to “real property.” Before, Section 1031 referred to “property,” so including cryptocurrencies was an arguable point. However, it is clearly settled that Bitcoin and cryptocurrencies are not “real property,” so they cannot qualify for like-kind exchange.
The Bottom Line
If your history of reporting and compliance with Bitcoin and cryptocurrency requirements is in question, it’s easy to feel unsure about the shifting nature of the law. Cryptocurrency users who are concerned about these issues and want to stay safely on the right side of the law should explore their situation and discuss alternatives with an IRS Bitcoin tax lawyer. For a consultation with an experienced tax attorney with a deep understanding of Bitcoin and other cryptocurrencies, contact the Tax Law Office of David W. Klasing.
