Cryptocurrency and Taxes: The Impact of Mining, Spending and Trading
June 25, 2018
When it comes to cryptocurrency and taxes, ambiguity reigns. Bitcoin and Ethereum are still in the early stages of development, and their values are extremely volatile.
As of early December 2017, one bitcoin was fluctuating between $15,000- $18,000, and its value has changed dramatically over the past year alone.
Cryptocurrencies are designed to be a more efficient and reliable form of decentralized currency that anyone can buy and sell through online exchanges. They can be digitally traded for or exchanged into U.S. dollars, euros or any other form of currency (real or virtual). With the right computers, they can also be “mined” using complex computerized algorithms to uncover new cryptocurrency value, much like mining gold.
But as cryptocurrencies grow in popularity and value, what are the tax implications for mining, trading and spending?
Buy, Sell, Trade
Whenever cryptocurrencies are mined, bought, sold, spent or traded, there are tax implications.
Taxpayers who receive crypto as payment for goods or services must determine the fair market value in U.S. dollars when received.
Taxpayers who mine coins are subject to tax on the fair market value on the day mined. Depending on the business structure of the miner, the income could also be subject to self-employment tax.
Enter the Taxman
Accounting for cryptocurrency is just as important as accounting for buying and selling stocks and bonds.
In 2014, the IRS declared cryptocurrencies should be treated as property for U.S. federal tax purposes and follow the general tax principles applicable to property transactions. This means they’re subject to capital gains tax, similar to stocks and bonds or real estate.
In some cases, you may be considered a trader and the net income from your trading activities could be ordinary income.
Do people have to track the cost of acquiring each cryptocurrency or token? How can they offset gains with losses? Will the IRS consider tokens to be property just as cryptocurrency?
Heads or Tails?
A recently introduced bill aims to make up for the lack of regulations. The Cryptocurrency Tax Fairness Act (CFTA) of 2017 would require the IRS to provide additional guidance on how transactions of more than $600 should be reported.
But how should miners and traders prepare?
- Establish a record-keeping system: Create a reliable record-keeping system that identifies your cost-basis method and exchange rate. The key to ensuring income is measured accurately? Keep detailed records of transactions. Keep separate wallets for short-term trading, long-term buy-and-hold positions and personal spending.
- Track costs: Consider third-party exchanges or wallet services to track your cost basis. The IRS requires you report the fair market value for the date the currency was received. Unless they have a consistent method of tracking daily value, active traders with short-term capital gains might be taxed like day-traders as business income, and not capital gain.
- Converting: Remember that taxes are paid in dollars. Think about converting your crypto to dollars on a regular schedule so that you have enough dollars to remit any income tax if due.
- Tax deferred exchange: There are some considerations that exchanging one cryptocurrency into another could be reported under IRS Code Section 1031 as a like kind exchange and the tax can be deferred. But, if between currencies you move in and out of ‘fiat,’ then this would not be available. In some cases, only an exchange on the same blockchain could qualify for these benefits — for instance, Bitcoin for Bitcoin Cash. In other instances, any cryptocurrency for another may qualify for this tax benefit. The currently proposed tax legislation has proposed that only real estate transactions would be able to use this tax strategy in the future. That will make 2017 the last year you can exchange one cryptocurrency for another on a tax-deferred basis.
- Spending: The IRS has determined that spending crypto is the same as if you sold it. So, if you are loading your crypto on a debit card or going to an ATM and drawing cash, those transactions are as if you just sold your crypto, and you have to track your taxable gains or losses.
- What about those tokens: We do not believe an exchange of crypto into tokens qualifies under Section 1031. The purchase of a token would be as if you sold your crypto and purchased another asset. Though the IRS has not ruled that tokens are considered “property,” we believe that is likely going to happen in the future.
Understanding the taxation of cryptocurrency is a challenge, at best. Values are highly volatile. The IRS inevitably will take an official stance on regulations.
Without professional tax and accounting help, taxpayers may find themselves on the wrong side of the coin.
- Read more related content: The Tax Impact of a U.S. and Non-U.S. Token Sale
About the Author
Mitchell is the partner-in-charge of Aprio’s Tax practice as well as the Technology & Biosciences group. He has been a partner since 1990 with Aprio, which is the largest Georgia-based tax, accounting and consulting firm. Mitchell works with companies in the software, gaming, clean tech, financial technology (FinTech), health care IT, processing, biosciences (biotech and medical device) and manufacturing industries. Whether a company is pre-revenue, starting up, growing or preparing for a liquidity event, Mitchell works with them to maximize their potential at each stage. He is known for promoting research, innovation and entrepreneurship by enabling companies to be successful, regardless of where they are in their business lifecycle.