Bitcoin had a banner year in 2017. Though it’s been around for almost a decade, the explosive growth experienced in 2017 has piqued the interest of investors and the IRS alike. As Bitcoin and other cryptocurrencies become more mainstream, savvy investors are advised to take a proactive approach to their tax planning and compliance surrounding these issues.
While IRS guidance on the subject is limited, they did provide some clarification regarding the taxation of cryptocurrencies in Notice 2014-21. According to the Notice, cryptocurrencies are treated as property for federal tax purposes. This important distinction means that the rules applicable to property transactions must also be applied to cryptocurrencies. Depending on the type of transactions a taxpayer is involved with, this can have a variety of implications.
Sale or exchange – The conversion of a digital currency into another form of property creates a taxable event. This includes converting cryptocurrency to cash, and even the exchange of one before exchanging it you will be eligible for digital coin for another, such as exchanging Bitcoin for Ethereum. Also, where there was ambiguity in the past the new Tax Reform and Jobs is clear – cryptocurrency does not qualify for a tax-free exchange under §1031.
Spending – Even the purchase of goods or services with cryptocurrency can create a taxable event. The transaction is treated as if the coin was first liquidated for cash, and then the cash was used to make the purchase. For example, if you bought a coin for $100 and later used that coin to purchase $500 worth of goods, you have a taxable gain of $400.
Receiving – The receipt of cryptocurrency in exchange for goods and services is taxed as ordinary income.
Mining – Successful mining of digital currency is considered ordinary income equal to the fair market value of the coin on the date it’s mine.
Initial Coin Offering (ICO) – Unlike traditional stock offering, an ICO can be sued to raise capital without giving away equity. However, the capital raised then becomes taxable income. Companies seeking a way to mitigate these taxes are looking to foreign markets with favorable regulatory environments.
Other Considerations – Like other property transactions, the holding period matters. If you have held the coin for longer than a before exchanging it, you are eligible for the favorable long-term capital gain rates.
Record keeping, an often-underappreciated aspect of taxation, is especially important when dealing in cryptocurrency. Digital exchanges like Coinbase are not subject to the same reporting regulations as traditional stockbrokers, so don’t expect to receive a Form 1099 detailing your annual trading activity. In crypto, the onus of recordkeeping falls to the taxpayer. Taxpayers would be well served by keeping detailed records about the initial purchase price, holding period, and exchange of any digital currencies.
This information will be required for both self-reporting and as support if the IRS ever comes knocking.
Our digital currency team at RJI CPAs is available to help you navigate the evolving tax law surrounding cryptocurrencies and its impact on your activity.
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Jeff Elkins
Jeff Elkins is a licensed CPA in California and Tax Manager at RJI International CPAs. He has an extensive background in income tax planning and compliance for corporations, partnerships and high net worth individuals. Specializing in closely held businesses, Jeff’s focus is on helping his clients minimize their tax liabilities and create multi-generational wealth as they grow their business. Jeff can be reached at 949.852.1600 or jelkins@rjicpas.com
Fernando Jimenez, CPA, MST, CEO
Fernando Jimenez is the Chief Executive Officer and tax partner of RJI CPAs. Fernando has experience in corporate re-organizations, buy/sell transactions, representation before the IRS and state agencies, succession and operations planning, and transactional analysis. He can be reached at 949.852.1600 or fjimenez@rjicpas.com.
About RJI International CPAs
Established in 1980, RJI specializes in audit, accounting, corporate and international tax issues for publicly traded and privately held companies. RJI is PCAOB registered and the Southern California member firm of DFK International, one of the largest accounting networks in the world.
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