Understanding Initial Coin Offerings, Tokens, and Their Tax Treatment

By now, most people have heard of virtual currency. Whether it be Bitcoin, Bitcoin Cash, Etherum, or one of the several other cryptocurrencies, digital coinage has become mainstream. Recognizing the proliferation of cryptocurrency, some startups looking to raise capital have turned to Initial Coin Offerings (ICO’s) as a viable fundraising option without the regulatory hassle of traditional securities offerings. Considering that the tax treatment of cryptocurrencies itself remains less than clear, ICO’s have added an additional layer of complexity to the tax analysis of investing in and with digital currency.

What are ICO’s?

Conceptually, ICO’s are very similar to Initial Public Offerings (IPO’s). Business ventures in their early stages that seek start-up capital make an initial offering to the public. In an IPO, investors receive stock in the company that they are investing cash in. ICO’s offer investors tokens in exchange for regulated local currency or for other cryptocurrencies such as Bitcoin. Ventures that have sought ICO’s as a source of decentralized funding range from the development of a new cryptocurrency to the development of a movie or game.

What are Tokens?

When an investor buys-in at an ICO, he or she receives tokens in exchange for real money or other cryptocurrency. Depending on the startup behind the ICO, you may be able to use your token(s) to buy goods, exchange them for services, or convert them into a new cryptocurrency once it is developed. Some tokens grant holders the right to a share of the profits of the venture. In such cases, tokens can act very much like securities that are heavily regulated by the Securities and Exchange Commission (SEC).

The SEC’s Position on ICO’s and Tokens

During the initial wave of ICO’s the SEC observed and didn’t make any sudden moves. But recently, the SEC has issued a wave of subpoenas to parties that they believe are involved or have been involved with an ICO that may have issued securities. The SEC website’s section on ICO’s takes the position that tokens obtained in an ICO may be securities, based on their characteristics. They also remind the public that if a token is a security, it is federal law that both the ICO and the security is federally registered. From the SEC’s subpoena activity, it appears that a federal crackdown on at least some ICO’s is underway.

What are the potential tax consequences of participating in an ICO?

In Notice 2014-21, the IRS took the position that “convertible virtual currency” is property and its sale is governed by the general rules dealing with the disposition of property. General tax principles dictate that the sale of property held for investment yields capital gain or loss and likewise, the sale of property held as inventory yields ordinary income or loss. Thus, when an investor buys or sells Bitcoin, he or she should expect capital gain or loss treatment upon its subsequent exchange, whenever that may be.

The tax treatment of tokens received in an ICO is more uncertain. Tokens themselves are not virtual currency in the sense that their transactions are recorded in their own blockchain. Though, that is not to say that there isn’t a market for tokens received in an ICO. Although a token can only be used functionally within its own particular venture (for instance, a token may be exchanged for gaming equipment once developed), tokens may be sold to another investor who sees value in the token (potentially a higher value than the token was originally obtained for).

Notice 2014-21 defines convertible virtual currency as virtual currency that has an equivalent value in real currency. Although a token may be viewed as a voucher of sorts, intended to be redeemed for other property, it is possible that like cryptocurrency, tokens fall under the guidance of Notice 2014-21 because they could have an equivalent value in real currency.

Considerations for those participating in an ICO

For those that have, or are considering, taking part in an ICO, the potential tax treatment of such transaction should be considered. Assuming that tokens fall under the guidance of Notice 2014-21 or are simply treated as property generally, using U.S. dollars to buy tokens in an ICO would appear to give the buyer a cost basis in the token. Because government-regulated currency (the U.S. dollar) is used in the purchase, it is unlikely that there would be any gain or loss recognized by the purchaser at the time of the transaction.

While keeping the above in mind, many ICO investors use cryptocurrency to acquire tokens. In this scenario, gain or loss may be recognized on the ICO exchange. If an investor purchased a unit of cryptocurrency for $100 two years ago and is now exchanging the same unit for $200 worth of tokens, it appears that the investor would recognize $100 of capital gain (assuming that he or she held the cryptocurrency for investment and not as inventory).

Many cryptocurrencies and token exchanges (such as Coinbase) are under heavy scrutiny by the IRS. It appears as if it is only a matter of time until online exchanges will be required to report gains or losses related to cryptocurrency or token sales (considering the blockchain recordkeeping of pricing and ownership). If you are a cryptocurrency or ICO investor, it may be in your best interest to contact an experienced tax attorney to determine the personal tax consequences of your investments.

When to contact a Cryptocurrency Tax Attorney

The tax and accounting professionals at the Tax Law Offices of David W. Klasing have experience representing clients with investments in cryptocurrency. By staying on the cutting edge of cryptocurrency and ICO developments, our team of zealous advocates are poised to effectively assist you. Contact the Tax Law Offices of David W. Klasing today for a reduced-rate consultation.

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.

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.