In a more detailed statement, Notice 2014-21, the IRS added the following specific guidance:
- For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.
- In calculating gain or loss on a transaction involving a virtual currency, the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.
- When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.
- The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
This last point is important. As with trading in securities, if a taxpayer trades cryptocurrencies at a level that would characterize him as a dealer and his cryptocurrency holdings as is inventory, then the IRS could take the position that his gains will be treated as ordinary income rather that capital gains.
New Liability Faced by Cryptocurrency, Bitcoin Trades from Tax Bill
The recent Tax Reform Act, which President Trump signed into law in December 2017, contains a provision that increases the tax liabilities of investors wanting to exchange ether, bitcoin and other types of virtual currencies that have increased in value. This legislation eliminated investors’ ability to defer taxes when one virtual currency is exchanged for another one when the original currency has increased in price. This impact comes from the Act’s provision limiting the availability of 1031 “like-kind” exchanges of property to include only real estate property exchanges.
This change in the tax is coming as the Internal Revenue Service (IRS) is ramping up investigating personal tax returns for possible unreported gains on virtual currencies.
In the past, some virtual currency investors and tax specialists treated all exchanges of one virtual currency for a different one as a tax-free like-kind exchange of property. The tax change coming from the new Act will be widely felt due to the skyrocketing increases in prices of cryptocurrencies such as bitcoin.
Under the Act, exchanges of one virtual currency for another will now be a taxable event. Virtual currencies are considered by the IRS to be property that is taxed at capital gains tax rates, as discussed above.
Scrutiny from The IRS
The change will have the biggest impact on people who are wanting to maximize their investment through trading various cryptocurrencies for one another. Now, investors will need to calculate what the current price is and the price when they purchased it originally. The investor will need to pay capital gains tax on the difference between the two prices, even if they are just purchasing a different type of virtual currency.
This Act is expected to trigger a new focus on reporting during a time when the IRS is increasing its scrutiny of cryptocurrency transactions. On November 28, Coinbase, a virtual currency exchange in San Francisco, was ordered by the U.S. District Court for California’s Northern District to disclose some of the company’s account holder to the IRS as part of an investigation by the agency into potential tax fraud.
Taxation Considerations in Structuring an ICO
ICOs directed at non-U.S. investors often are made through a subsidiary domiciled in an offshore jurisdiction. These are generally jurisdictions with stable and friendly governments and sophisticated banking resources that impose no taxation on the ICO transaction or its investors. Examples include several Caribbean nations, such as the Cayman Islands, British Virgin Islands and Nevis; Malta and Belarus. One advantage is that by employing an offshore subsidiary of a U.S. company seeking to do an ICO, the investors are isolated from the withholding taxes imposed on interest, dividends and gains of non-U.S. investors in U.S. companies. The regulations in this area are very complex, and an expert in international taxation should be consulted early in the process.