I’ve been receiving inquiries recently about the taxation of cryptocurrency transactions. In addition to responding to individual queries, I’ve decided to summarize my opinions on certain issues that have come up.
DISCLAIMER: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax advice. You should consult your own tax advisor with regard to your particular tax position.
- Are trades involving cryptocurrency taxable?
Using USD to buy crypto is NOT taxable. Crypto-crypto trades ARE taxable. Think of it as a sale of crypto into USD (taxable gain/loss) simultaneous with a purchase of another crypto.
- Can I treat my crypto-crypto trades as Section 1031 like-kind exchanges?
As far as treating cryptocurrency trades (crypto-crypto) as like-kind exchanges, this is a murky area. Other than ruling in 2014 that crypto is property (vs currency) for tax purposes, the IRS hasn’t said anything specific about whether crypto trades qualify as 1031 like-kind exchanges. The new tax bill limits sec 1031 exchanges to real property, so 2018 and beyond crypto trades would be treated like a stock trade for tax purposes. If you are talking about a relatively small amount of profit, the safest thing to do is simply report the gains on form 8949 which feeds into schedule D. While it is possible that if the issue were ever to come under review a tax court could rule that pre-2018 trades qualify as like-kind exchanges, this is not guaranteed. If you decide to go this route (claim like-kind exchange), make sure that you have detailed records, and preferably a letter from a CPA, attorney, enrolled agent or another individual qualified to present cases to the IRS, supporting your position. Of course this all will cost money, so you would want to weigh the costs and benefits.
- How do I minimize my tax liability when trading cryptocurrencies?
Given the 2018-forward treatment of crypto trades, the question of minimizing your tax liability gets easier to answer, as stock traders for years have been grappling with this issue. Assuming that you are not going to be a full-time trader, and could not qualify for “trader” status (and run the expenses from trading through schedule C), another option is to form a legal entity to house your trading activity. However the benefits of this are dependent on a lot of variables, such as your other income, trading activity, etc. My understanding is that it’s worthwhile only in a very few situations, due to the complexity involved. In addition, the beneficial treatment of pass-through entities that was included in the new tax law is not applicable to LLCs or S-corps whose primary business is trading. That said, best to consult a tax attorney knowledgeable with tax law and corporate formation to discuss this. If you do not go the legal entity route, and do not qualify as a trader, then your best route for minimizing taxes is to “HODL” for 12 months to take advantage of lower capital gains rates.
- I’m using arbitrage to take advantage of price differences between cryptocurrency exchanges. How will I be taxed on this?
For tax purposes you need to think of every crypto-crypto trade as a simultaneous sale of crypto into USD, then the use of USD to purchase the second crypto. The sale of the first crypto into USD is the taxable event. Let’s assume you are arbitraging between price differences on Bittrex and Binance. Since neither Bittrex nor Binance trade USD pairs (tether doesn’t count), you need to refer to some source to estimate the sale price, in terms of USD, of your crypto. CoinMarketCap.com (CMC) is a widely cited source, but there are others; use what you prefer as long as it’s defensible.
Another way to look at it is to look at your net position at the end of the year vs your starting position. For example, if at the beginning of the year you put $100 into 100 coin A and through the magic of arbitrage turned that into 800 coin A by the end of the year, then assuming constant exchange rates you have $800 at the end of the year and a $700 gain. Yes, individually the trading events are taxable, and if you are doing extensive trading you might have to make quarterly estimated tax payments, but I am simplifying for this example.
- I engage in cryptocurrency margin trading. How am I taxed?
Any gains/losses are reportable on Form 8949; expenses (e.g. margin interest) can be deducted on Schedule A if you itemize; subject to the 2% AGI threshold. If you qualify as a trader according to the IRS, then expenses are categorized differently.
- Am I taxed if I buy into an ICO?
Buying into ICOs may or may not be a taxable activity, depending on what you use to purchase the coins/tokens. If you use fiat/USD then it is not a taxable activity; however, if you use another cryptocurrency then you will likely cause a taxable event. In the latter case you would recognize a gain/loss at the time you relinquish control of the crypto used in the purchase, measured as the difference between the value at the time of the exchange and your basis in the currency. Note both are measured in USD. The basis on the coins/tokens received would take into account any presale bonuses that the buyer might qualify for. So for example, if you paid $100 for 100 XYZ tokens in a presale and received a 30% bonus, then each token would have a basis of $100/130 or $0.77 (rounded).
- What site do you recommend for calculating gains and losses on crypto trades?
I have used both cointracking.info and bitcoin.tax. If you want to feel comfortable with the output from cointracking.info, I suggest that you feed the same reports into bitcoin.tax and compare the results. I found that both sites calculate basis the same way, but use different selling prices (probably due to different sources) to calculate gains and losses. Hence the total gains and losses might be higher or lower for one site’s report vs. the other’s.