If tax day makes you nervous, you might want to refrain from trading cryptocurrencies—at least until the Internal Revenue Service clarifies how the hell it intends to tax them. Navigating the legal gray areas left by today’s rules can be a bit like wandering through a minefield.
The lack of guidance isn’t new. But now that cryptocurrency has gone mainstream, thanks to the initial coin offering boom and the Great Bitcoin Bull Run of 2017, there’s a lot more money on the line—and far more confused cryptocurrency users.
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Taxing properties: According to a 2014 guidance (PDF) from the IRS, cryptocurrencies are considered property, which makes them subject to capital-gains and income taxes. Buying and holding cryptocurrency is not a taxable event. But if you use digital coins to buy anything—even just a cup of coffee—after your holdings have increased in value, you’ve experienced a gain, and that’s taxable. So for every purchase, you must report the amount you spent and the difference between the currency’s value when you spent it and the value when you first got it. If you came out ahead, you have to pay tax. Fun.
Headaches for the hard-core: Generally speaking, the more devoted a cryptocurrency user you are, the more complicated it is to track everything the IRS needs, says Chandan Lodha, cofounder of CoinTracker, which has developed software meant to help with tax preparation for the crypto set. If you do things like trade on multiple exchanges, trade multiple coins, or execute swaps of one cryptocurrency for another, “you have to do a bunch of work in accounting and record keeping in order to have any hope” of getting your taxes right, he says.
Pay the Man later: Some traders have managed to avoid paying taxes on cryptocurrency-for-cryptocurrency trades by appealing to something called the “like-kind exception,” which lets people defer tax payments when trading one property for another, similar property. For instance, if you trade your house for another one, which then gains in value, you don’t have to pay taxes on that gain until you have the cash for it (since the increase in value is tied up in the house itself). But a provision in the new tax law signed late last year limits this exception to real estate, meaning cryptocurrency traders must pay taxes on crypto-for-crypto trades made after December 31, 2017, when the law took effect. What about trades before that? That’s less clear.
What ... the ... fork? Nothing exposes the of lack clarity on cryptocurrency taxes quite like a “hard fork,” an event in which a blockchain network splits and creates a second currency. A hard fork of Bitcoin last August that created Bitcoin Cash resulted in a windfall for Bitcoin users, if they wanted it—the same amount of Bitcoin Cash as they held in Bitcoin. Was that income? If so, how should they determine its value for tax purposes? The IRS hasn’t offered any guidance.
The taxpayer’s call: The gray areas don’t end there, says Lodha: as with everything crypto, the rabbit hole goes deep, and some people are trying all kinds of tricks to cut their tax bills. But whatever they do, Lodha says, cryptocurrency traders have a choice. “Would you rather be safe than sorry, but maybe overpay your bill? Or do you want to gamble and then maybe you’ll get audited and maybe you’ll have to pay interest and penalties?”