THURS, JAN 25th, 2018
The IRS has provided little guidance regarding virtual currencies such as bitcoin, Ethereum, and Litecoin. The most notable IRS publication, Notice 2014-21, states “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.”
What does this IRS statement mean to virtual currency users? It means that you will need to file and/or pay taxes if you traded, sold, or used virtual currencies to make a purchase. Consider the following scenarios:
1. If you bought a virtual currency and sold it for a gain, the gain should be reported on a Form 1040 Schedule D and taxed in the same manner as realized gains from the sale of a stock. Long-term and short-term rules apply; losses can be used to offset gains; and, gains/losses from virtual currencies will be netted with gains/losses from other capital assets.
2. If you bought goods or services with virtual currency and the value of the item received is greater than (or less than) the price paid for the virtual currency, the difference in value is considered a realized gain (or loss) and needs to be reported for tax purposes.
3. If you were given virtual currencies as payment for services rendered either as an employee or contractor, the value of the currency is considered earned income and needs to be reported as such. Coins earned through the process of mining are also considered earned income.
There has been a lot of uncertainty regarding the tax implications, if any, of selling one virtual currency to buy another (i.e. using bitcoin to buy Ethereum). Although there has been some use of Section 1031 like-kind exchanges, the most prudent reporting for tax purposes would be to treat this transaction as you would treat selling shares in one company to buy shares in another. A taxable event is triggered with the sale of the shares and the basis in the new shares is specifically what you paid for them. In fact, the new tax reform bill restricts Section 1031 exchanges to real estate only, so going forward this will not be a viable tax tool in the virtual currency world.
Offshore activity with virtual currencies is another complexity to be addressed. Offshore activity will require use of ‘Report of Foreign Bank and Financial Accounts’ (FBARs). If you store cryptocurrency on an exchange that is based outside of the United States, you may be required to disclose this on the FBAR Form 114 if the value of your account(s) is greater than $10,000 at any point during the calendar year. Additionally, you may need to file Form 8938, Statement of Specified Financial Assets, with your tax return.
There are several accounting and tax compliance tools available including BitcoinTaxes and CoinTracking which are designed to help investors calculate capital gains taxes and income for virtual currencies. We strongly recommend using one of these tools or a tracking system of your own design if you are engaged in virtual currency activity.
Owning Virtual Currency in an IRA
Another tax related question often posed is whether you can own virtual currency in an IRA. The answer is yes, but only in self-directed IRAs which are capable of holding unconventional assets like real estate, precious metals and virtual currencies. The tax rules for self-directed IRAs can be complex and missteps can have serious consequences. It is important to understand exactly what rules will apply to you and precisely in what you are investing. We expect additional clarity on this topic as virtual currency investing becomes increasingly mainstream.
The investment team at Albion Financial Group is well versed in bitcoin / cryptocurrencies and blockchain technology. Please reach out to us at 801-487-3700 or firstname.lastname@example.org if we can answer your bitcoin, investment, or financial planning questions.
Albion Cryptocurrency Team
Disclaimer: Information provided is for educational purposes only. This is not a recommendation to buy or sell any security or cryptocurrency. There are significant risks associated with cryptocurrency that are unique and must not be taken lightly. It is critical that you perform your own due diligence prior to engaging in any buy or sell transaction. The value of bitcoin can, and may, ultimately go to zero.