How many bitcoin investors are not up to speed with the IRS crackdown? Millions, probably. Coinbase has 35 million customer accounts. The number of taxpayers reporting crypto trades was, until recently, in the hundreds.
If it was once hard to plead ignorance of tax laws regarding crypto, it’s now impossible. The new Form 1040 demands that taxpayers say whether or not they own any virtual currencies. The yes/no question parallels the one that was implemented years ago on offshore investment accounts and led to nasty treatment of people who lied.
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1. Cryptocurrency is property.
Bitcoin and its competitors look a lot like money: they’re a store of value and a means of exchange. But the Internal Revenue Service has decreed that these assets are not currency and not securities either. They are property. More like a shopping mall than like a $100 bill.
As capital assets, they give rise to capital gains and losses when disposed of. A profit is taxable as a short-term gain if a position has been held for a year or less, as long-term if held for more than a year. If a coin is held for profit rather than amusement, which is presumably almost always the case, then a loss on it is a deductible capital loss.
In computing a gain or loss you use as your starting point the “basis” of an asset, tax lingo for your original purchase price (after, occasionally, some adjustments).
2. Sales are not the only form of taxable transaction.
You have to report the disposition of a virtual coin if it is:
—sold for cash,
—traded for another crypto, or
—used to buy something.
But merely transferring coins, such as from a wallet to an exchange or vice versa, is not a disposition. Nor do investors who buy and hold owe a tax.
3. The tax code’s wash sale rule does not apply.
This rule forbids the claiming of a loss on sale of a security if you bought that security within 30 days before or after. If, for example, you buy a Tesla share at $800, sell it at $720, then buy it back quickly, the $80 loss is suspended.
But bitcoins and the like are not “securities.” They’re pieces of “property.” So you can go out at a loss and then right back in without losing the right to immediately claim the loss.
4. Exchanges squeal.
Coin exchanges based in the U.S. file information returns on customers with a lot of trades. The 1099-K is mandatory for a customer who in one calendar year does at least 200 transactions with proceeds totalling at least $20,000. This is the same cutoff for other intermediaries handling property transactions, such as Ebay. (Some states have lower thresholds.)
The 1099-K form is rather like the 1099-B that stockbrokers file, except that the latter form doesn’t have the 200-trade minimum and the K probably won’t tell you what your cost basis was for a coin.
As with 1099-Bs, so with the Ks, the fact that you didn’t get the form (because you didn’t do a lot of trading or for any other reason) does not absolve you of the obligation to report all sales and other dispositions.
5. Forks can create ordinary income.
When a share of stock splits in two, by and large, there’s no taxable transaction. Its purchase price gets carved up and assigned to the two pieces; you declare a sale on either of those pieces only when you dispose of it. If and when you do sell a piece at a gain you’ll get the favorable capital gain treatment. This is what would happen if one share of Exxon Mobil split into one share of Exxon and one share of Mobil.
The IRS has a different view of coin splitups that occur when a blockchain forks into two chains. It thinks that the split creates a windfall equal to the starting value of the newly created coin, and that this windfall should be taxed at high ordinary-income rates.
This is what happened when bitcoin (BTC) spun off bitcoin cash (BCH) in 2017. Each old BTC coin continued to live on one chain while one newly created BCH, on a new chain, was dropped into the lap of the BTC owner. You were supposed to declare the value of BCH as ordinary income. It’s a good bet that many coin holders neglected to do so.
How does the tax agency justify its rule? With some very strained logic. It sees a coin split as less like an oil company splitting in two than it is like a taxpayer stumbling on a $100 bill in a parking lot.
The new currency created by a fork is income when you can get your hands on it. This is true even if you hold on to the new currency. The cost basis for the new coins is whatever you had to report as income.
6. Airdrops create ordinary income.
An “airdrop” is the random distribution of coins in the course of a marketing effort. (The IRS has also used the term, incorrectly, to describe the spin-off explained in the previous section.) With considerably more justification than it has taxing forks, the IRS considers marketing giveaways to be ordinary income.
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