How are Bitcoin and other Cryptocurrencies taxed?

 

Bitcoin and other cryptocurrencies have increasing popularity.  Last year cryptocurrencies were frequently in the news due to their volatile price fluctuations. This made many millennials and other age groups into billionaires, as well as others to lose significant amounts of their invested savings. Though several ups and downs, in 2017 the value of the cryptocurrency market cap went from 17.7 billion to 572.6 billion a 3200% growth.   With the gained popularity, more and more people are investing and asking us about the tax regulations regarding bitcoin and other cryptocurrencies. Here we explain cryptocurrencies at glance.

What is a Cryptocurrency?

It is a monetary unit that is created, exchanged, and stored electronically, using encryption techniques to control the creation and the transfer of funds.   Bitcoin was the first cryptocurrency, and it was developed in 2009.  Bitcoin and most other cryptocurrencies are built on blockchain technology.  This technology is powered through “mining” servers which process transactions.  The owner of the mining servers, known as “miners” are rewarded with the coin they are  processing the transactions.

How to Buy Cryptocurrencies?

Bitcoins and other cryptocurrencies are traded through a digital “exchange”.  There are several different exchanges, and due to different country laws, not all are properly regulated if at all.  If you are considering to buy any cryptocurrency, you should make sure you find a regulated Cryptocurrency Exchange.  In some environments, virtual currency operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.

When are they taxed?

In the U.S., cryptocurrencies are only taxed when a benefit or value is received in exchange for the cryptocurrency.  Examples include converting into Fiat money like US Dollars and Euros, or if used in exchange for services, products, tangible or intangible assets such as stocks, property, bonds, etc.  The taxable amount would be the value of what was received, minus the cost of the initial investment, plus any costs incurred in between like  transaction fees, attorney, internet connectivity, etc.

How is IRS taxing Cryptos?

The IRS states that virtual currency is treated as property for U.S. federal tax purposes.  General tax principles that apply to property transactions apply to transactions using virtual currency.  Among other things, this means that:

  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply.  Normally, payers must issue Form 1099.
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. 

Is capital gains tax avoidable like other investment assets?

Well up until 12/31/17, it may have been arguable that Cryptocurrency could possibly had qualified for a 1031 “Tax-Free” Exchange.  However, that loophole was closed with the latest December 2017 Trump Tax Reform, when the recent tax law changes specified the IRS Code Section 1031 would only apply to real estate transaction going forward.

What property qualifies for a Like-Kind Exchange defined by the IRS?

Both the relinquished property you sell and the replacement property you buy must meet certain requirements. 

Both properties must be held for use in a trade or business or for investment.   Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

Both properties must be similar enough to qualify as “like-kind.”  Like-kind property is property of the same nature, character or class.  Quality or grade does not matter. Most real estate will be like-kind to other real estate.  For example, real property that is improved with a residential rental house is like-kind to vacant land.  One exception for real estate is that property within the United States is not like-kind to property outside of the United States.  Also, improvements that are conveyed without land are not of like kind to land.

Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property.  As an example,  cars are not like-kind to trucks. 

Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:

  • Inventory or stock in trade
  • Stocks, bonds, or notes
  • Other securities or debt
  • Partnership interests
  • Certificates of trust

Whether cryptocurrencies become an actual currency or not, they are currently taxed as a capital investment.  Remember, it is an investment subject to tax even if you don’t receive cash in the sale of the coins.  If you have any other tax questions related to cryptocurrencies and other taxation requirements, contact us.

If you need assistance, Rosillo & Associates, www.RosilloCPA.com and we can assist you at (305)477-5671.

 

 

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