By Keith Buckley and Nick Richards
Virtual currency has been around for more than a decade, but recently it became more attractive to consumers and investors and prevalent in the public’s eyes. In 2017, Bitcoin, the most prominent virtual currency, saw a surge in valuation from $967.83 a coin on December 31, 2016, to peak price of $18,975.02 on December 16, 2017. With this rapid rise came large windfalls of wealth through gains from the sale of Bitcoins. The question now, with 2017 tax returns due on April 15th, how do you report this gain?
The Internal Revenue Service (IRS) has had virtual economies on its radar since at least 2007. They recognized that there was tax on the sale of virtual currencies even though tracking such sales was a difficult task. In 2014, the IRS issued IRS Notice 2014-21 to clarify its position on convertible virtual currencies. A convertible virtual currency is real currency that has an equivalent value to other global currencies such as the US Dollar. The Revenue Ruling remains to this day the best guideline of how to treat sales and exchanges of Bitcoin, Ethereum, Litecoin, and other virtual currencies for tax purposes.
Classification of Virtual Currency
IRS guidance provides that convertible virtual currency is property. As property, it is subject to the same general tax rules and regulations applicable to the purchase and sale of property in the United States. This allows the holder of virtual currency to realize gain or loss upon the sale or disposition of the currency. Further, the holder of virtual currency may treat the virtual currency as a capital asset and, if it meets the requirements, may be allowed capital gains treatment for tax purposes.
Value/Basis of Virtual Currency
Similar to stocks, virtual currency has a basis which is the original purchase price of the currency. The basis in a “Coin” is the fair market value of the currency (USD) as of the date of receipt. Therefore, if the holder purchased one Bitcoin on December 31, 2017, their basis in that one coin would be $967.83. This value represents the fair market value determined by the supply and demand of Bitcoins on that date.
Due to increase and decrease of demand for virtual currency, it is important for holders of virtual currencies to determine the fair market value of their currency per each acquisition. Failure to do so may result in over reporting or under-reporting any gains or losses upon disposition or sale of the currency.
When Does Virtual Currency Become Taxable
Holding onto convertible virtual currency that increases or decreases in value does not create any tax consequence to the holder. A taxable event arises upon the sale of disposition of the currency. This taxable event occurs whenever the currency is traded for cash or other virtual currency, or whenever it is used to purchase goods or services.
Failure to Report
There are claims that cryptocurrency is untraceable and does not have to be reported to the IRS. This is untrue. The IRS takes notice of such transactions in order to reign in what some may consider the wild west of currency. Failing to properly report the income tax consequences from a cryptocurrency transaction may result in stiff penalties and possible criminal prosecution to the taxpayer.
The IRS has the ability to audit your tax return for discrepancies related to cryptocurrency. This includes the power to summons currency exchanges and holders of virtual currency. Recently, the IRS was able to require Coinbase to furnish information about its users, including their transaction and spending history, with the purpose to identify users who have engaged in a taxable event such as selling of cryptocurrency. (U.S. v. Coinbase Inc., Case No. 17-CV-01431)
In addition to IRS audits, the IRS may impose civil penalties and interest upon taxpayers who did not report cryptocurrency transactions. Further, a taxpayer may be subject to criminal prosecution for tax evasion and filing a false return.
Overall, the IRS has taken a special interest in virtual currencies within the past few years and appears to be upping its enforcement against taxpayers that hold virtual currencies and exchange them through large currency exchanges.
If you have traded, sold, or disposed of virtual currency in the past three years be sure to know your tax exposure. Dill and Dill helps individuals defend their tax positions and resolve their tax matters. If you are interested in more information on Cryptocurrencies or are facing a state or IRS audit, we are here to help. Contact us directly at (303) 777-3737 or at firstname.lastname@example.org.