How Are Investments in Initial Coin Offerings (ICOs) Taxed?

If you’re an active user of Bitcoin, Litecoin, Ethereum, or other cryptocurrencies, you may have already invested in an Initial Coin Offering, or ICO. To provide some context for those less well-traveled in the realm of digital currency, in an ICO, “coins” or “tokens,” which can be purchased using fiat currency like USD, are released to fund a unique cryptocurrency project. As one bulletin released by the U.S. Securities and Exchange Commission (SEC) succinctly explains, “Promoters may tell purchasers that the capital raised from the sales will be used to fund development of a digital platform, software, or other projects and that the virtual tokens or coins may be used to access the platform, use the software, or otherwise participate in the project.” Unfortunately, while this may sound like a novel or lucrative approach to investing, unwary investors can be hamstrung by laws regulating the purchase or sale of securities, which may be applied to tokens and/or coins offered through ICOs. Before you rush to invest in an ICO, make sure you understand the potential tax impacts of federal securities laws – and if you’ve already started investing, seek guidance from an experienced Bitcoin tax attorney as soon as possible.

How Are ICO Coins and Tokens Treated for Tax Purposes Under SEC Rules?

In 2014, the Internal Revenue Service (IRS) issued a rudimentary set of regulatory guidelines, Notice 2014-21 (IRS Virtual Currency Guidance), in which Bitcoin and other virtual currencies were classified not as currency, as the term would suggest, but rather property. To quote the notice, which can be viewed in full here, “General tax principles applicable to property transactions apply to transactions using virtual currency.”

Of course, as our cryptocurrency tax attorneys wrote about on a previous occasion, these early guidelines proved unable to keep pace with a rapidly expanding industry. This prompted the Treasury Inspector General for Tax Administration (TIGTA) to release a report recommending that the IRS “provide updated guidance to reflect the necessary… tax treatments needed for the various uses of virtual currencies.”

Unfortunately, rather than providing clarity, these waves of regulation have largely served to create even deeper confusion for most crypto users – particularly because in 2017, the SEC further determined that ICO tokens could, in certain cases, be treated like traditional securities, a category which encompasses “any note, stock, treasury stock, bond,” or other instruments as defined under the Securities and Exchange Act of 1934.

Unsurprisingly, this classification can have significant tax repercussions for ICO investors, as the U.S. Tax Code contains numerous regulations that specifically apply to the sale of securities. In particular, current (or would-be) investors should be mindful of the following:

  • Hard Forks – A “hard fork” can develop if cryptocurrency miners use atypical software to validate transactions in the “blockchain,” the continuously growing ledger where transactions are publicly posted, typically as a result of a disagreement among developers. Readers are advised to see our article explaining what hard forks are and how they could affect your tax bill.
  • Like-Kind (1031) Exchanges – There has been some confusion as to whether Bitcoin qualifies for 1031 exchange treatment, but the general consensus is that the safe answer is “no” – especially considering the fact that 1031 exchanges are typically inapplicable to conventional securities, such as stocks and bonds. Our tax attorneys would refer readers to our article concerning virtual currency and Section 1031 for more detail.
  • Wash Sale Rule – When a security, such as a stock, bond, or ICO token/coin, is sold at a loss, the loss is typically disallowed if the security is purchased again during a two-month window (which opens 30 days before or prior to the sale, depending on the circumstances). This “wash sale rule” does not, under existing guidelines, appear applicable to all virtual currency transactions – but it does affect ICO coins/tokens categorized as securities by the SEC.

For more information on cryptocurrency taxation, curious readers might be interested in viewing our articles on the following subjects:

Bitcoin Tax Lawyers Can Answer Your Cryptocurrency Questions

The regulations (and even basic legal definitions) pertaining to Bitcoin, Litecoin, and other digital currencies are among the messiest and most ambiguous issued by the IRS or SEC. Even when a taxpayer intends to comply, it is easy to be misled by the abundance of confusing, sometimes contradictory advice surrounding this evolving field of tax law.

Fortunately, there is no need to navigate the regulatory maze on your own. If you are thinking about investing in an ICO – or if you are simply a crypto hobbyist who is worried about your history of compliance with government regulations – it is in your best interests to discuss your concerns with a knowledgeable cryptocurrency tax lawyer. With the IRS already clamping down on Coinbase, whose competitors are likely to meet the same fate, today – not tomorrow – is the time to revisit your tax obligations. To discuss cryptocurrency-related or ICO-related tax issues in a reduced-rate consultation with an experienced tax attorney, contact Tax Law Office of David W. Klasing online, or call our tax law firm at (800) 681-1295 today.

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 BernardinoSanta BarbaraPanorama City, and Oxnard! You can find information on all of our offices here.

Here is a link to our YouTube channel: click here!

What are the current challenges in calculating your basis gains and losses in cryptocurrency

https://www.youtube.com/watch?v=2dimHMqHlN4

When is an 8949 required when reporting cryptocurrency

https://www.youtube.com/watch?v=-U9RJsihjQM

What is it about cryptocurrency that’s so likely to get me either audited or criminally investigated

https://www.youtube.com/watch?v=8oSCndQSgR4

How is cryptocurrency taxed

https://www.youtube.com/watch?v=QJgUAdWMQsE

What are the basic tax implications and reporting requirements for cryptocurrency

https://www.youtube.com/watch?v=NW-kTbGgwb8

Users can contribute computing resources to mine bitcoins

https://www.youtube.com/watch?v=O2YsIcyajE8

What is Bitcoin and other forms of cryptocurrency

https://www.youtube.com/watch?v=ToxEF5GHI-o

Can a tax preparer have criminal liability where they counsel a client not to report cryptocurrency

https://www.youtube.com/watch?v=rRwO4dun-4s

Is there real criminal exposure, if you failed to report prior year cryptocurrency non compliance

https://www.youtube.com/watch?v=TqfzGEVQleA

What should you do if the IRS or DOJ may have just received your cryptocurrency trading history

https://www.youtube.com/watch?v=1kxdLw9Qp6k

Is it possible to do a 1031 where cryptocurrency is concerned

https://www.youtube.com/watch?v=Y-CuUqKXlSM

Here is a link to our FAQ library on Bitcoin and other cryptocurrencies

https://klasing-associates.com/topics/bitcoin/

Here is a link to our practice page on the taxation of virtual currency.