US Tax Considerations – Crypto to Crypto Trades: Trading Bitcoin and Altcoins

in tax •  2 years ago

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Back when I had a semi-regular series running about US Taxation and cryptocurrencies, I always ended each post by opening the floor to the community for questions which they would like to have featured with some general answers.

Almost one year later, @swansong decided to step forward and take up the offer:

Quite a bit to unpack in all that, but a common question lives in the root of it all. If I’m actively trading alternative cryptocurrencies on exchanges such as Poloniex and Bitrex, do I owe capital gains tax after each trade or is the capital gains tax delayed until I convert to fiat?

Let’s take a deeper look.

But First, the Legalease…

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor is it a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Cryptocurrencies are Defined as Property

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According to the Internal Revenue Service guidance issued on March 25, 2014 Internal Revenue Notice IR-2014-36 IRS Virtual Currency Guidance, the IRS issued guidance which unequivocally states Bitcoin and all other “convertible” digital currencies (read altcoins) are taxed as property for United States income tax purposes.

Transactions Exchanging Property Covered by Barter Rules

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Imagine we are trading Bitcoin and other “convertible” digital currencies on an exchange such a Poloniex or Bitrex. With the guidance issued under IR-2014-36, the IRS has effectively classified the exchange of “convertible” virtual currencies as a trade of one property for another property. This exchange would be viewed as a barter of one fairly valued property for another fairly valued property and would be subject to barter rules.

As a general rule, any time property is either sold for USD or exchanged for another property in a barter transaction (such as Bitcoin for other convertible digital currency in this case), a tax event has occurred. It requires and individual to compute the quantity (USD value) and the nature (long term or short term) of the capital gain or loss at the point of sale or exchange of the property. If you are looking for more detailed insight on how to calculate capital gains and losses, please see my earlier post US Tax Considerations When Blogging for Magic Internet Money (Part II). However, certain types of property exchanges permit the capital gains tax to be deferred until a later period when one disposes the property through sale or exchange for a different property.

Welcome to the world of Like-Kind Property Exchanges.

Section 1031 Special Kinds of Property Exchanges (Like-Kind)

For purposes of this article, the scope of the 1031 analysis will remain in the realm of convertible digital currencies.

Title 26 §1031- Exchange of Property Held for Productive Use or Investment speaks to tax advantages ascribed to exchanges of like-kind property (sale or barter) held for productive use in business or investment. The most common application of this section of the tax code is with real estate purchases for construction/land development, rental and industrial property purchases.

While any exchange of property triggers a tax event, Section 1031 of the US tax code carves out a niche for a particular kind of property exchange which permits one to defer the capital gain from the exchange until the 1031 property is disposed (sold for USD or exchanged for non-like kind property), so long as the property exchanged is of like-kind.

What makes two properties like-kind?

According to Internal Revenue Service Fact Sheet FS-2008-18: Like-Kind Exchanges Under IRC Code Section 1031, the IRS provides the following broad definition of like-kind property:

“Both properties must be similar enough to qualify as ‘like-kind.’ Like-kind property is a property of the same nature, character or class.”

On the surface, the definition of like property provided by FS-2008-18 would suggest trading digital currencies (such as Bitcoin for Ethereum) on exchanges would constitute like-kind property exchanges. However, when reading through Title 26 §1031, some exceptions to this rule are outlined.

§1031 Excluded Properties and Cryptocurrencies

For purposes of this article, a specific exclusion under Section 1031 gives pause as to whether or not trading convertible digital currencies qualify for the Section 1031 like-property designation.

Title 26 §1031(a)(2)(c) This subsection shall not apply to any sale or exchange of other securities or evidence of indebtedness or interest.

It has been suggested the Internal Revenue Service may define convertible digital currencies as securities or as interests in a particular blockchain, effectively negating the ability to classify crypto to crypto trades as like-kind exchanges of property. However, no clear guidance has been issued.

Does the Trade of Convertible Digital Currencies Fall Under §1031 Like-Kind Property Exchange Rules?

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It is an excellent question with no clear answer because no guidance has been issued by the Internal Revenue Service on this subject, and a host of others regarding convertible digital currency. On at least three separate occasions the IRS has been asked for guidance on this topic:

As of the time of this writing, no new guidance has been issued. In fact, after TIGTA’s report and public hearing in Congress, the only action taken by the Internal Revenue Service on the matter of convertible digital currencies was to subpoena all user information from Coinbase in a blanket “John Doe” summons.

The takeaway from this lack of guidance leaves a ton of risk in the lap of the taxpayer.

While it would seem logical that Section 1031 would apply to a trade of cryptocurrencies (as they are deemed capital assets), this treatment cannot be confirmed without specific Federal and State guidance on the question of whether one cryptocurrency is like-kind with another. Since no guidance on this subject currently exists, 1031 exchanges of differing types of cryptocurrency, while not outright prohibited, is not guaranteed to be a tax-free exchange.

A more conservative taxpayer would calculate the capital gain on every trade. They would report out the capital gains (or losses) and pay out any capital gains tax in the year the trades were made.

A less conservative taxpayer may choose to treat the trades as §1031 Like-Kind Property Exchanges, calculate and defer the capital gains from each trade, then report out and remit all deferred tax due when they trade out into fiat. The risk with this strategy is the Internal Revenue Service could issue guidance at a later date, which excludes convertible digital currencies as like-kind property exchanges, and the taxpayer will need to amend prior period returns and face fines and penalties associated with failing to file and remit taxes due in those prior years.

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Thanks for the detailed post! Personally I always prefer to take the conservative approach with IRS. After reading your post I'll treat ICOs and exchanges between virtual currencies as a tax event. Hopefully we will get clearer guidance soon.
BTW, this brings up the question of whether choosing the conservative approach here is indeed elective, i.e., should IRS provide guidelines in the future that the aforementioned events do qualify for 1031, would you then need to amend your return even if you prefer not to?

I am not US resident reading your post I have a question. Why cryprocurrencies are treated different from stock markets. Why tax is not charged as per stock markets? Nice post, got some knowledge about US taxation. Thanks.

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@shirish5 thanks for the read and the comment. I appreciate it.

Currently cryptocurrencies are broadly defined as property, but no guidance has been issued regarding how the tax treatment should be. As a result, they fall into a very broad category for US Tax purposes. I would imagine with the way ICOs are exploding and with bigger businesses and banks (Microsoft, JP Morgan Chase, etc.) moving into the space, the issue will be forced in the very near future.

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Maybe the people should force the issue of ending the IRS.

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Thanks for the clarification.

if cryptos too get taxed what the motto left ... :(

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I have been using CoinTracking for the past two years and all I can say are good things. One of the smartest customer support I've ever experienced. I've used about 4 other portfolio tracking, and none come close to what CoinTracking offers, usability and design is great.

The companion app is amazing as well. Now I can quickly see a snapshot of all my investments, regardless of where they are located, in one easy to use app.

Although the free version is good, import each CSV file from each exchange is time consuming, with the PRO version all your transactions are up to date with one time setup.

You can use my affiliate link which gives you 10% discount.

Hope this helps!

This is so confusing. Great article and it's going a good point-of-reference for those who use exchanges. It sounds like I'll mark my taxes when I put money on my BitPay card, but I did not notice much attention on using purse.io/ or paying for electricity. That could be a useful following. Nice job!

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@urbanist thanks for taking the time on a Sunday to read through and comment on a tax article of all things.

I would advise speaking to a tax pro and determining the best solution for your case in the event there are any questions. As a licensed tax pro, I'd like some clarity already otherwise it comes across as a game of gotcha.

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Thanks! It's all very interesting because I want to pay my taxes as a part of the social contract and then bitch when they spend them poorly! Mostly, I just want to make sure everything's on the up-and-up. I'll probably be talking to a pro -- though few even know the term bitcoin I would imagine. My attorney still calls it "bit-com"

Excellent [email protected]!

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@scalerman thanks for taking some time to read and comment. I appreciate it.

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Thanks back @lpfaust! Im familiar with 1031 exchange with real estate..hadn't even considered it on crypto's! Im pretty new to this crypto world. Following you :)

I appreciate that You collected informations from different sources and it takes time
Such a Valuable post 👌
@lpfaust

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@heelzkinu thanks for reading and commenting. I'm glad you took the time to check it out.

This post was very helpful! I was just wondering about this because I started to convert and sell to usd on coinbase..good info!

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@correctdrop thanks for taking time to read and comment.

I would advise since you trade on Coinbase to get your records in order because they have been hit with a John Doe subpoena from the IRS. As I understand it, the IRS has either agreed to or has been ordered by the court to limit the scope of the demand from Coinbase. It's increasingly appearing that Coinbase will be compelled in some fashion to produce some records to the IRS.

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The've backed off slightly, only requesting info on those Coinbase customers who have moved US$20k through their account.

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Indeed!

a very good post , you talked about the right things

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@cityslicker thanks for the read and comment. I, glad you found some value in the content.

I'm not a citizen but I don't see why cryptos should be taxed. The government has nothing to do about how we get our earnings. WHATSOEVER. Cheers!

#follow4follow #upvote

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@nibzter thanks for reading and commenting on a tax article of all things.

The purpose of the article always not push a personal viewpoint. Rather it was to provide some answers to questions about US Tax treatment of crypto trades.

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I feel you. I'm very new the US tax treatment for crypto

great post,hope every country not impose it on cryptocurrency.

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@starving thanks for the read and comment. I appreciate the interest and support.

The good news is not every country is following the lead of the US regarding taxation on cryptocurrencies. The bad news is if you are a US citizen using foreign exchanges for trading, you may be required to disclose all accounts with aggregate trades and value in excess of $10,000 on an FBAR in addition to disclosing them on an annual income tax return.

As I said earlier, I'm not promoting a viewpoint, I'm simply providing information.

It's really stupid that the same taxation that applies to stocks, doesn't apply to cryptocurrencies...

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@arcturian thanks for the read and the comment. It's much appreciated.

Not sure I would support that. Should all property be taxed identically assuming all of it will be taxed? Not sure I agree with that. In fact, I'm not sure I agree with crypto being taxed as a property. From my standpoint it should have the same treatment as every other fiat currency.

Thanks for the information

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@supremum thanks for taking the time to read and comment. I appreciate it.

I do not live in the States, but I also do not know how my country's tax officials will treat money on a crypto currency. I'm afraid there will be problems.

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@dlina-v-metrah thanks for stopping by to read and comment. It's appreciated.

My personal feeling on the subject is in the world of ever inflating debt, crypto will be perceived as a threat. The response by most, I believe, will be to either tax it to continue providing revenue for their bad spending habits or, as most recently happened in Poland, denounce it and attempt to make it illegal.

Fascinating... didn't realize 1031 had potential applications beyond real estate... would be great for them to issue (positive!) guidance on this... Thanks for the post!

Great article one of your recent posts took me here. I recently wrote an article on the like kind exchange, analyzing parallels with the IRS's treatment of physical gold; it's a read that you might enjoy.

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@cryptotax very awesome article. I enjoyed reading about the parallels with gold and silver because of the similar correlation between that and cryptos.

After reading through the 1031 Excluded Properties, I had even speculated in my article that crypto may fall into this category. Even if one puts aside the uncertainty of the SEC's ruling about ICOs falling into a case by case basis to determine if a crypto is a security, one more interesting question is if holding tokens implies interest in the protocol (such as in a Proof of Stake or Delegated Proof of Stake scenario).

My hope is given the increased interest in cryptocurrency from the varying regulatory bodies, guidance and/or legislation will be provided in the near future.

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Thank you! I hope for some guidance soon as well on like kind. Also how a hard fork is treated is a whole second issue that needs to be addressed. Until then, we can only speculate. I will follow you for future posts. Myself, I plan to write about tax/finance topics weekly. Steem on!

This post received a 3.5% upvote from @randowhale thanks to @lpfaust! For more information, click here!

End the IRS!

This is wrong govt should not interfere everywhere.

Thanks very much for the tax info!

Thanks for writing lpfaust (I love the name). Just to update everyone, the new tax law makes it clear that crypto for crypt trade is NOT like for like trade. making trades on a crypto currency exchange is taxable. See the article for details: https://www.forbes.com/sites/robertwood/2017/11/27/tax-bills-doom-tax-free-1031-exchanges-of-cryptocurrency/#4ad2081af58f

I hope this helps.

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This doesn't take affect until you have to file your 2018 taxes next year.