Tax attorney Tyson Cross and CPA Jason Tyra discuss all things crypto and taxes, including what types of crypto transactions are taxable events, how you’ll be taxed on hard forks — relevant for those who owned Bitcoin last August 1! — and whether you can deduct a loss if you lose your private keys or exchange loses your coins. Plus, they reveal the top question they get from crypto enthusiasts and their top recommendations for people who love crypto but want to minimize their tax headache.
The tax rules that have crypto users aghast article and show notes
Transcript:
Laura Shin:
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Laura Shin: 00:00:32
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Laura Shin: 00:00:53
The topic of today’s episode is taxes in crypto, and my guests today are tax attorney Tyson Cross of Cross law group and CPA Jason Tyra of Jason M. Tyra CPA PLLC. Welcome Tyson and Jason.
Jason and Tyson: 00:00:53
Thanks for having us.
Laura Shin: 00:01:09
One disclaimer, before we dive in, while we hope the show is informative for everyone, this is not meant to be financial advice and anyone who has any crypto holdings should seek their own personalized tax advice. So, Jason, let’s start with you. I think taxes are fairly stressful for people in general and when you throw in crypto and its complexities, their heads just start to spin. So let’s start with the broadest question possible. but for the purposes of today’s discussion, we will mostly stick with US tax regulation.
Laura Shin: 00:01:36
What is the overarching principle that helps explain how the government is taxing crypto transactions?
Jason Tyra: 00:01:43
The IRS refers to crypto currencies using the term virtual currency and the substance of guidance provided by the IRS was back in 2014 with notice 2014-21, which specified that virtual currencies would be treated as property for tax purposes. For most users what that means is that there’ll be treated as capital assets, which makes them substantially similar to either stocks or bonds for most transactions. So you have a purchase, a holding period, a disposal, and then a gain or loss on the transaction, depending on what your basis was and what the disposal value was.
Laura Shin: 00:02:34
What you’re saying is that people need to know what price they bought it at, how long they held it for, and then whether or not they made money or lost money during that time period. Is that what you’re saying?
Jason Tyra: 00:02:44
That’s correct. It’s almost exactly the same as a stock transaction. So for users that are familiar with the reporting requirements for those, they’re substantially similar.
Laura Shin: 00:02:55
Tyson, what would you say is the overarching principle that you think about how the government is taxing crypto transactions?
Tyson Cross: 00:03:03
Jason described it pretty accurately. I guess the one thing I would add, because of the determination by the IRS that virtual currency is property. That means that every single exchange of virtual currency is a taxable event. So if you use virtual currency to buy a cup of coffee that is qualified as a taxable event, if you exchange one type of virtual currency for another, that is also a taxable event. It’s not just transactions where virtual currency is sold for fiat.
Laura Shin: 00:03:40
Here’s another reason why crypto and taxes have been in the news. Some of the listeners may have heard about the Coinbase summons. It actually was the subject of a podcast last winter, roughly a year ago. People should go back and listen to that if they’re interested in this topic. Why don’t you guys describe what happened there and why this case is relevant to listeners?
Tyson Cross: 00:04:00
Essentially what happened was an IRS office issued a summons to Coinbase. Seeking all Coinbase’s US customer’s records. it was extremely broad summons. It wanted all information that Coinbase had essentially on their US customers, including things as mundane as chat support logs. There was quite a big dispute about that. Several parties attempted to intervene. Coinbase ultimately also disputed or challenged the summons. And, that ultimately concluded in a court ruling back in late November that more or less granted the IRS’s summons against Coinbase. Although with some modification, the most important one being that coinbase only has to provide records of customers who had more than $20,000 of transactions of any type, such as a sale, a deposit, or withdraw. So any users whose dollar value of transactions of those types exceeded $20,000, Coinbase will be providing those records to the IRS.
Laura Shin: 00:05:15
Why do you think the IRS wanted with just that level of detail? What was the impetus behind their summons?
Tyson Cross: 00:05:24
Frankly, it was a fishing expedition. The IRS is concerned that people are using cryptocurrency for tax evasion or at the very least have taxable income that they’re not reporting from cryptocurrency. And the IRS pointed to essentially one example, although there’s other parties involved, of someone they did more or less catch committing tax evasion using virtual currency. And that was the basis for them seeking all records of all US customer from Coinbase. So they are trying to look at cryptocurrency users and identify people who are evading taxes, although I think a lot of people in the legal community would agree is that it was an over-broad and essentially a fishing expedition.
Jason Tyra: 00:06:16
I’d like to add a little something to that if I can.
Laura Shin: 00:06:19
Yeah, go ahead.
Jason Tyra: 00:06:28
Part of the IRS, sommons was a note that for 2015 something like, less than a hundred returns were filed that declared virtual currency activity. To kind of extend the narrative of the fishing expedition. My firm by ourselves filed more returns for that year with virtual currency activity. So I’m not sure where the IRS got that number. We can’t be the only ones, but just my firm filed more returns than that.
Laura Shin: 00:06:55
Oh Wow. Oh that’s interesting.
Tyson Cross: 00:06:58
I’d add to that. So did my firm. So, I think you have two people on the line right now that may have exceeded that number the IRS reported as being the tax returns that were filed.
Laura Shin: 00:07:09
Huh? I wish I had known that back when we were writing articles about this before the case was settled because that’s kind of interesting that their justification wasn’t even based in fact. But, I wanted to define this term fishing expedition. Are you basically saying they didn’t have any evidence of wrongdoing of any particular people, but just wanted to get as much information as possible and then find those people? Is that what that means?
Tyson Cross: 00:07:38
So, a fishing expedition, essentially the idea is to cast a broad net and they catch everything. And maybe they’re looking for the bad fish, but with a broad net like that you catch the good ones too. And the concern with that is that US people have rights under the fourth amendment to prevent intrusions of their privacy like that. And so typically the government is required to show that it has a reasonable basis for seeking that kind of information and belief that criminal activity is occurring and having one or two or three, maybe small examples of it doesn’t seem like it’s enough to justify obtaining the private information of millions potentially of a US based customers.
Laura Shin: 00:08:17
And then how do they determine tax evasion versus ignorance? Or is it the same thing in the eyes of the tax man?
Jason Tyra: 00:08:27
There’s not really a meaningful difference from an enforcement perspective, The vast majority of cases where there’s under reporting of income or under reporting of tax don’t necessarily go to the criminal stage. That’s where you would have tax evasion. That would be a criminal issue. So there’s not a meaningful difference if they’re just looking to collect revenue and most cases don’t go to a criminal phase anyway.
Laura Shin: 00:08:58
Let’s go back to what Tyson talked about how these tax regulations apply in so many different instances of types of transactions. It sounds like it applies if you use bitcoin to pay for a lamp on overstock as well as if you are a day trader, trading in like penny stock type coins. Or, if you’re an employer who’s decided to pay your employees in ether. So,what are some other examples of different ways in which you might use crypto currency, where you would have to be thinking about it as if you were selling or purchasing stock?
Jason Tyra: 00:09:38
The payroll in the ether example is a good one because one thing that a lot of our clients overlook is the requirement to accrue and remit payroll taxes on those payments. So, that has to be done in just the same way as if you were paying in cash. We have clients that are high speed trading. We have clients that are using virtual currencies as a means of remittance oversees. The thing is a virtual currencies are fungible in a way that stocks or not. There’s a lot of things you could do with them. Especially with ether now, with the ability to write and carry out smart contracts, you really can’t do that with securities. So there’s just a lot more things going on that could generate tax consequences than with just a generic share of stock.
Laura Shin: 00:10:34 Earlier when you were saying that people would need to record their cost basis, Like the price they bought something at. Let’s say that I have been buying, just for simplicity sake, let’s just say it’s bitcoin over a period of time, obviously because bitcoins are fungible, I don’t know what price I would count and let’s say I had to gain by the time I sold some or spend some or whatever. How would I calculate that? What’s the price from which I should count my gain? Is it the most recently purchased bitcoin or the oldest bitcoin I have? How does that work?
Jason Tyra: 00:11:09
This is actually something that a lot of our clients struggle with. And, the good news is that the exchanges keep records that are pretty much what you need from a taxation perspective for you. So the answer is your basis is whatever you paid. And the IRS doesn’t specify how you have to match buys with sells as long as they’re the same amount. So first in first out works, last in first out works. if you want to go through and cherry pick and do the matching by hand that way that would work also. ‘d be extremely time consuming, but you could do it. So yeah, there’s not a lot of guidance provided by the IRS in this area specifically.
Laura Shin: 00:11:56
Last in first out is like using your most recently purchased crypto. And then first in first out is using your oldest. But, is there one that you generally recommend for people or does it depend on their own personal circumstances?
Jason Tyra: 00:12:10
We generally recommend first in, first out. And the reason is we have a habitual relationships with clients that we’ve been working with for a number of years and first in first out, is the easiest way in the same dataset to ensure that you don’t mark the same lot of coins as a dispose more than one time. However, we admit that this year has been extraordinary. And so that will not always result in the lowest possible tax outcome. In a falling rate environment, it would. In a rising rate environment, it would not. And this is definitely a rising rate environment.
Tyson Cross: 00:12:56
I would also tend to agree. We also default to first in, first out for clients. The issue here. This is just one of many problems or I should say the finer details of crypto currency taxation that the IRS has failed to provide guidance for to US taxpayers. And so, people are struggling with determining something as simple as which method you use for calculating your cost basis. And, first in first out is I tell clients probably the safest option because it is the most widely accepted or used in other types of property. And so if you really want to make sure that you have no potential issues down the road with the IRS. or them declaring that some other methods you used is not a reasonable method for crypto currency then first in first out would be the safest option.
Tyson Cross: 00:13:52
The problem with that is there’s no IRS guidance. Taxpayers right now are forced to choose. Do you adopt a method that is safest and can result in you paying more taxes. Or, do you adopt a method that’s better for you from a tax standpoint but potentially may expose you to some dispute with the IRS down the road. And that’s a very unfortunate position for taxpayers to be in. And I think the IRS really needs to make an effort to clarify some of these things so that people don’t have to decide between those two non preferable option.
Laura Shin: 00:14:21
And do you think that the IRS will eventually provide guidance on that? Or did you think that that’s something that they’ve purposely left up to individuals?
Tyson Cross: 00:14:36
It’s hard to say. They are very understaffed, under budget at the IRS. They’re busy and frankly, crypto currency is not a very large segment of the population right now. And so, I think the resources are probably better applied elsewhere. With that said, it seems like they should at least make some effort. Like Jason pointed out earlier, the last time they provided notice was in 2014. And so it’s been four years now. So, I think it’s time for some of these issues to be clarified. Hopefully they provide that guidance sooner rarther than later. It may cause more issues if they do it at the end of March, like they did last time right before the filing deadline. People may have already filed. But, in general they’ve been criticized for not providing guidance already by the tax payer advocate and other agencies. So, I think it is probably time for them to make that effort.
Laura Shin: 00:15:27
And if they do clarify things, will that be something that needs to apply retroactively or will it just to play going forward?
Tyson Cross: 00:15:35
The problem is that it can apply retroactively. They’re not creating new law. They’re just clarifying their interpretation of how the existing law applies to crypto currency. So, it is in fact actually possible for it to apply retroactively. But we would hope that in this situation, since there’s been so much uncertainty about many of these issues that the IRS takes a stance with more of a forward looking approach instead of making tax payers agonize over whether they need to go back and amend previous tax returns that aren’t consistent with the guidance that the IRS ultimately provides.
Laura Shin: 00:16:14
If you’re saying that the IRS is understaffed, then maybe they will also think that that’s a good idea because then they won’t have to deal with all those amended returns.
Laura Shin: 00:16:21
I wanted to ask about something else which you mentioned, what information the exchanges give to you. So, what exactly do they make available to their customers and does it depend on where the exchange is based? For instance, if I use Coinbase and let’s say Binance. Do I get different information from the two of them?
Tyson Cross: 00:16:43
That’s the problem right now in this space is that there’s no standardized form of reporting. So, certainly exchanges are free to report different information. Generally, they all make the basics available to you as far as buys and sells and deposits and withdraws. I’ve seen issues and maybe Jason would agree with some of the ways that margin trades are reported or short sales are reported. That can make it difficult when you go into tax time to calculate someone’s capital gains.
Laura Shin: 00:17:16
What are the complexities there? How is that different from what you’ve already described?
Tyson Cross: 00:17:21
The issue is in the way that those types of trades are settled at the exchange. Some of these exchanges will place those trades. A margin trade or short sale for instance. It shows up in your report, just like any other trade, although when it’s done on the platform, they essentially just a settle it out against your position, so they’ll just pay you the profit you make or take away the loss you have from your holdings there on the site. And so you do end up with sort of inconsistency in the way that it’s treated at the exchange. First, mechanically how it’s actually reported to the user.
Jason Tyra: 00:17:57
I would add to this, this is a real challenge for us because each exchange keeps records their own way. And some exchanges don’t keep records in a way that’s easily accessible to users. Especially the exchanges that are outside the United States. So, it could be something as simple as terminology, where a sale is referred to as a sell or a sale. Or, it can be something as dramatic as what Tyson just pointed out. There’s no unified reporting regime. I really thought that there would be a 1099B requirement forthcoming. It doesn’t look like that’s going to happen anytime soon. So, we’re just kind of left with what the exchanges decide to do for us.
Laura Shin: 00:18:45
You know, I was wondering about that 1099B thing because that was something that Brian Armstrong proposed when Coinbase was in its legal battle with the IRS. As far as I know, they didn’t take them up on the offer. Which was surprising because it just seems like a pretty common sense solution here. Do you have a sense of why that was?
Jason Tyra: 00:19:08
I just don’t think that the IRS can create a new requirement. I don’t think that’s something they can just do as a deal with one particular constituency. Tyson would probably be a better one to answer this than me.
Tyson Cross: 00:19:31
Proceduraly, the IRS can’t impose that 1099 filing requirement just unilaterally in a negotiation with Coinbase. Ultimately it’s going to get there. 1099’s will become a requirement for US based exchanges. I’m sure it’s just a matter of time.
Laura Shin: 00:19:41
So wait, does that mean that it’s a different agency that would impose that requirement and not the IRS?
Tyson Cross: 00:19:51
No, the requirement for a 1099, I think it just wouldn’t be appropriate to make that determination as being a settlement in a negotiation deal with Coinbase.
Laura Shin: 00:20:00
I’m not saying that they would do that just for that one case, but that they might take that suggestion and say, “Hey, this is a smart idea as an agency. We should issue some new regulation to make this a requirement across all crypto exchanges.” I don’t know how that would work exactly but something like that.
Tyson Cross: 00:20:21
That’s a good question. I’m not exactly positive. We’d have to check the statute. Generally, statutes on tax matters prescribe the general outline and then allow the secretary to basically make decisions based on how that’s going to happen and the details of what those requirements would look like. From that standpoint, it is possible that it could just come out of the IRS. Deciding that a 1099B is a requirement that virtual currency exchanges have to comply with. One problem though is that virtual currency is fungible and it’s very easily transferable. Unlike shares of stock that you buy and sell, typically on the single brokerage, you can move these around. And that makes the information that the particular exchanges can report on 1099B less than useful because they don’t have your cost basis information. All they can do is report perhaps your sells. But they don’t know how much you paid for that coin. If you bought bitcoin on Coinbase, for instance, and transferred it to Bittrex and sold it at Bittrex. A 1099B from Bittrex may only report the sale and it may actually make things more complicated for taxpayers to accurately calculate their income. Since those 1099B’s wouldn’t be very accurate.
Laura Shin: 00:21:41
What are you recommending to your clients? Are you having them create their own spreadsheets or something to track all this themselves?
Tyson Cross: 00:21:50
Coinbase is actually confusing a lot of users or at least my clients, Jason, maybe yours too, because they’re providing a tax report now, where you can calculate your taxes. But, if you deposit a coin to Coinbase, they use the market price of the coin on that day as your cost basis and if you produce your tax report, it’s going to be completely erroneous. And I think taxpayers are actually going to rely on that report not fully realizing that it’s completely incorrect.
Laura Shin: 00:22:20
Yikes! That seems like something you should tweet at them and say,” Hey guys, you’re doing this wrong. You’re going to get the IRS to come after you again.”
Jason Tyra: 00:22:32
I think, they’re trying to help. I mean, they really are. They’re trying to prevent unwelcome regulation. Coinbase is not a tax preparation platform. And, I think most people realize that. The 1099B issue, to add on to what Tyson said before, could actually be prejudicial to taxpayers because the IRS uses 1099 information as a standard of reporting for income. So if you have coins that you liquidated for $50,000 during the year with no basis reported, the IRS is going to automatically assume $50,000 in profit. Anyone who’s ever gotten a CP 2000 notice, which is a mismatch between reported income and declared income notice, knows that the IRS doesn’t always get the whole picture. So I think that Coinbase is just trying to do their best to keep the IRS out of their business and that’s what their best looks like right now unfortunately.
Laura Shin: 00:23:36
So just going back, if I have bought my bitcoin somewhere else, but I moved them to Coinbase in order to sell them back in fiat into my bank account. Then it’s upon me, it sounds like, to make sure that I know what my cost basis was, so as not to have to pay, in this example not have to pay taxes on the full 50,000. Let’s say I spent 20,000, and then took out 50,000, the onus would be on me to log that I paid 20,000. Is that correct?
Jason Tyra: 00:24:09
Yes. And it’s also on you to report that at tax time.
Laura Shin: 00:24:14
The other thing I was wondering about is, a service like Coinbase, they charge 1.49% for transactions where you convert back to fiat and also when you buy. So do you pay taxes on the fee or what happens with the fee?
Jason Tyra: 00:24:32
It becomes part of your basis or it’s deducted from the proceeds of the transaction. It’s essentially a deduction from your gains.
Laura Shin: 00:24:41
And does the same thing apply if I’m transacting on the Bitcoin blockchain and let’s say I pay a $40 fee. What happens with that fee? How do I treat that tax wise?
Jason Tyra: 00:24:53
It would be the same. It’s deductible.
Laura Shin: 00:24:55
OK. And then for the hodlers out there. Do they pay any taxes? And if so, how much and what information do they need to record?
Tyson Cross: 00:25:07
Hodlers no. There is no tax consequence unless you actually engage and attract a taxable transaction. So that would be an exchange of goods, services, other property or money. So if you’re hodling, there is no tax on the appreciation that’s occurred in those holdings. And I’ll point out that’s another area where I see confusion among clients is that on Coinbase, if you withdraw your coins and transfer them to a new exchange. On that tax report, that Coinbase provides you it treats that as taxable sale. And, clients who see that are confused and we can clarify that the act of withdrawing a virtual currency from the exchange and moving it to a paper wallet or to another exchange is not a taxable event.
Laura Shin: 00:25:53
And then if you’re shifting coins that you bought, let’s say on the retail side of Coinbase over to GDAX the professional trading platform, is there any taxable event at that moment or no?
Tyson Cross: 00:26:06
No. The transfer of crypto currency from wall to dress, wall to dress as long as you were still the owner is not a taxable event.
Laura Shin: 00:26:17
To go back to my question about the hodlers, when they buy, that’s not a taxable event either, right?
Tyson Cross: 00:26:26 As long as they buy with fiat. If they use bitcoin to buy an altcoin, that would be a taxable event. It’s treated as if they sold the bitcoin for cash and bought the altcoin so they may have a taxable event there on the bitcoin side of that transaction.
Laura Shin: 00:26:43
Let’s talk more about crypto to crypto trades. Are those ever treated as like-kind exchanges? And can you also just define this term like-kind exchange?
Tyson Cross: 00:26:54
This is probably the most common question I get right now. Under section 1031, an exchange of property of like kind does not cause the recognition of gain or loss. And so the question is does cryptocurrency qualify as like-kind property? And the problem really is that crypto currencies in new asset class. We know it’s property. The IRS clarified that in the notice issued in 2014. It is at least technically eligible for like kind status under section 1031, but that’s not really enough. You have to look at the nature and character of the property itself and it takes a pretty in-depth analysis to determine whether the property involved is in fact like-kind and we don’t have any direct authority on point there. We have cases in regulations and IRS rulings interpreting the nature and character test for other types of property and so we can try to analogize cryptocurrency to these other types of property, but it just doesn’t fit very well because…
Tyson Cross: 00:28:04
This is a new asset class and it just tends to not fit very well within the existing legal framework. I tell clients or people who at least consult with me about this like-kind issue. It is possible for crypto currency to be like-kind and it’s certainly not, let’s call it illegal to report it that way on your tax return. But, the issue is that because there’s no direct authority, the IRS is effectively free to disagree and reach a different conclusion and reject the use of like-kind. If they do that, you as the taxpayer would have to either fight that out and possibly go to tax court or even higher courts to resolve the issue or simply pay the tax that they’ve assessed against you plus interest and then potentially penalties and the penalties are gonna apply if you don’t have a reasonable or adequate legal authority for arguing that crypto currency is like-kind property. That’s really what the issue comes down to is there sufficient authority to treat it that way? And if not, then you’d be facing penalties if you report it that way on your tax return.
Laura Shin: 00:29:17
Didn’t the recent tax bill also restrict that to only real estate or something like that?
Tyson Cross: 00:29:20
The new tax bill amended section 1031 and essentially makes like current exchanges going forward, only applicable to exchanges of real estate.
Laura Shin: 00:29:29
But it leaves open the question of what happened to light-kind exchanges in crypto before this new tax bill. Is that what you’re saying?
Tyson Cross: 00:29:39
Right, it is still on the table for previous years and it’s anyone’s guess on how the IRS is going to play this one. Based on the number of people asking me if they can file like-kind exchanges for previous years on crypto currency, I think that would probably be quite a few people doing it that way. The most important thing though is that they have to remember, just because it’s not taxable, it doesn’t mean you get to skip reporting it on your tax return. Like-kind exchanges still are reported on the tax return using form 8824. So, if you think that like-kind exchange treatment is sort of a easy way out of the reporting requirements and the difficulty of accurately tracking your crypto trades, it’s not. Those still need to be calculated and reported on your tax return.
Laura Shin: 00:30:24
Wow. For people who do a lot of that, that sounds like a total headache. All right, we’re going to talk about taxes on hard forks, airdrops, mining, lost coins, and for ICO issuers.
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Laura Shin: 00:31:09 I’m speaking with tax attorney Tyson cross and CPA, Jason Tyra about taxation of crypto. Let’s talk about hard forked coins. How will people be taxed on those? for instance, if I held bitcoin on August 1st, let’s say I had five bitcoins and then I therefore received five bitcoincash, how will I be taxed for these new bitcoin cash that I now hold?
Jason Tyra: 00:31:33
That’s a really interesting area because there’s not a direct analog in the tax code for a hard fork where you would typically see a property split under normal circumstances would be like a stock split where you have a two for one and the two shares of stock each have half the value of the one that you had before, or a property split incident to a divorce where you have, say a piece of property, that’s divided in half, but you don’t end up with more property than you started with. With a hard fork in the virtual currency land. You end up with something that’s new that didn’t take anything from where it came from, if you will. We’re suggesting to clients that they treated as a capital asset with a basis of zero and, and then that would start their holding period and there, there have a long or short term capital gain depending on how long they held the asset.
Laura Shin: 00:32:31
You recommend they start from zero. Well, what if they had bought their bitcoins and we’re holding them on a centralized service like Zappo or Coinbase, which did not make the bitcoincash available until months after it had been released. Then do you still recommend that they use zero as their cost basis?
Jason Tyra: 00:32:52
Yes we do. Bitcoin did not lose any value, or have any fundamental change at the time of the fork. So, the zero cost basis makes even more sense in the in the scenario you just gave because the point at which the client had an unrestricted right to the coin was different from when the coin actually forked. So as long as you assume a zero basis there’s, there’s no harm to the client.
Laura Shin: 00:33:23
OK. And would the same reasoning applied to something like air dropped coins where again, holders on a certain existing blockchain will suddenly received new coins?
Jason Tyra: 00:33:36
I think it’s less clear, and Tyson may disagree with me on this. I think an airdrop is different from a fork in that you kind of have to do something for the most part to participate in an airdrop. So, I would say that those coins usually would be considered ordinary income at the time received and that would establish their basis and then you would have a capital gain or loss from there. But, I would want to make that determination based on the circumstances of each individual airdrop event as opposed to on a blanket basis.
Laura Shin: 00:34:11
OK. What you’re saying is that you would pay taxes simply upon receipt of the coins because their income?
Jason Tyra: 00:34:16
That’s correct.
Tyson Cross: 00:34:21
If I can add Laura, I think this is a great example of where we need better guidance from the IRS because like Jason said, there’s no analogy for this in the tax code. It’s just a completely new concept of the hard fork. And I’ve written previously on this and basically, the thoughts I’ve shared really are more of a strict interpretation of the code. I think if you look really closely and take a very conservative interpretation. Both the hard fork and airdrop or taxable events at the time of the hard fork, but there’s serious issues with that viewpoint. And both practically and administratively from the IRS’s perspective, it’s essentially unworkable, I think because frankly, people don’t know about hard forks. Now, something as high profile, maybe as the bitcoincash, certainly did a lot. But, I assure you there are some people who had no idea. So requiring them to recognize income they didn’t even know about certainly becomes an issue.
Tyson Cross: 00:35:15
And the problem here is that we’re back to that situation where taxpayers have a difficult decision to make as far as do they pay more tax to be safe or do they take a more reasonable approach but risk some kind of issue with the IRS down the road. I have clients who are very early adopters and have very large bitcoin holdings. And so for your average person, the bitbitcoincash fork was several hundred or maybe a few thousand dollars of potential income depending on how you treat it. But, if you’re a very large early adopter of Bitcoin, I have one client in particular who was about $6,000,000 of income potentially from the bitcoincash Hard fork. So do they treat that as taxable income at the time of the fork or do they wait and take what I think is probably a more reasonable approach and use a zero cost basis like Jason was recommending
Tyson Cross: 00:36:09
The issue there is that if the IRS thinks that it was taxable at the time of the hard fork, they under-reported by $6,000,000 and that carries significant consequences with it. Those taxpayers are put in a very difficult position of deciding the correct way to treat it. So we do need guidance on that point. But I would just wrap that thought up by saying I tend to recommend the same way that Jason does as far as just using the zero cost basis and recognizing that game when the new crypto is disposed of.
Laura Shin: 00:36:36
Well I think it would be difficult with the bitcoincash to to figure out what the income was, right? Because it took kind of a while to figure out a price even. And then I don’t know if that price was consistent across different exchanges. Am I wrong? I feel like there was a lot of confusion initially.
Tyson Cross: 00:36:54
Yeah, and that’s one of many check marks on the box that say that it’s not administratively possible to treat the hard fork as a taxable event at the time that occurs. Evaluation is a good example of one of those problems with that approach.
Jason Tyra: 00:37:08
Also. That would be a terrible outcome for the taxpayer. But, let’s take that same hypothetical client with the $6,000,000 in gain. He reports $6,000,000 in ordinary income in year one, and then let’s say on the first day of year two, that bitcoincash had gone to zero. So now he has a $6,000,000 capital loss, which he can’t necessarily deduct against a $6,000,000 in income. And, because capital losses are limited to $3,000 per year, how long is that going to take to write off?
Laura Shin: 00:37:41
Let’s talk about another instance in which we have a new coin being created out of the Ether. Which is what happens with an initial coin offering. If I am issuing the new coin, then how am I taxed on that?
Tyson Cross: 00:37:57
You know, that was a very interesting question, one that maybe people tend to overlook. And, it’s sort of ironic because you do have a projects that are conducting an ICO. And, on one hand they don’t want to be a security because they do want to stay out of any sort of trouble with the SEC. But, on the other hand, if they’re not a security, they certainly are then selling a utility token is typically the nomenclature that’s used for that. Basically they’re selling a product or a service and under the Internal Revenue Code there’s a specific carve out for money raised through selling shares of stock or a membership interest in a partnership. That is why normal IPOs are tax free. Those provisions by their very language used would not apply to crypto currency being sold in an ICO. So, I’m curious to hear what Jason thinks, but I think that it’s taxable income to the sellers of the token.
Jason Tyra: 00:38:57
Yeah, I agree with that. We worked with a lot of companies that have put together ICO’s and there’s really only two ways you can go. It’s either a security or it’s a product essentially. And what we tell clients is that if you have not registered with the SEC, then you’ve, kind of made your bed in that respect. ou are going to have to pay tax on revenue.
Laura Shin: 00:38:57
And what if I mine crypto, how am I taxed?
Jason Tyra: 00:39:29
It’s just ordinary income.
Laura Shin: 00:39:37
If I’m paid in crypto, it’s ordinary income. What if I gift my crypto to somebody or do I pay taxes on that?
Jason Tyra: 00:39:41
In that circumstance, the gift tax rules would apply. There is a tax-free gift limit. It’s $14,000 per person per year. And under that limit you don’t even have to report. So let’s say you had a one bitcoin, which is a, let’s say it’s worth exactly $14,000, but it has a basis in your hands of 10. If you gift that to somebody, it just leaves your hands tax free. And then the recipient takes a carryover basis from you.
Laura Shin: 00:40:20
So you need to tell them what you paid?
Jason Tyra: 00:40:21
Yes you do. Once you go beyond the tax free gift limit, you start to eat into your lifetime, it’s like the state exemption limit and I don’t know what it is off the cuff. It’s in the millions of dollars. At that point you would be required to file a gift tax return, but you probably still wouldn’t owe any gift tax unless you had gone through your, your lifetime tax free gift limit.
Tyson Cross: 00:40:50
That limit just got raised to $11,000,000 if you’re single, 22,000,000 if you’re married with the new tax bill. Long story short, most people don’t need to worry about the tax consequences of gifting crypto. Although as Jason pointed out, if it’s over 14,000, you are required to file a gift tax return so the IRS can track how much lifetime exemption you’ve used up.
Laura Shin: 00:41:10
And what if I’ve lost my crypto? Meaning, what if I’ve lost my private keys? Maybe I was hacked or I throw out the hard drive they were on, can I deduct those losses? And if so, what amount do I deduct it on December 31st, or the amount from the time I lost them?
Jason Tyra: 00:41:27
That’s a good question. I don’t know. Tyson, a thrown away hard drive… is that a theft or casualty loss if you destroy your own property?
Tyson Cross: 00:41:40
You know, that’s interesting. there’s a lot of different fact pattern that can come up in this context for whether a loss as a casualty loss or theft loss. I run into clients all the time that have different examples of things happening. The exchange closed down or they were hacked or a tragic boating accident. Unfortunately, the first rule, I mean assuming you qualify for a theft or loss deduction and that’ll have to be determined with your tax advisor, I think to make sure. But the loss is based on what you paid for the coin. So right off the bat, most people aren’t too happy, frankly, about that outcome. There’s also phase outs on when you can even deduct the casualty loss on the tax return. And I’ll just add, finally, the casualty losses were one of those things that got thrown on the chopping block in the new tax bill. Actually going forward, there’s not a mechanism to deduct lost coins anymore whether they were stolen, hacked, or results of a crashed hard drive.
Laura Shin: 00:42:46
I’m floored by the fact that you said that the amount that you deduct is what you paid. Because obviously for people who have seen huge crypto gains, I’m sure they, they don’t like that. But then knowing that going forward, you can’t even detect any of these losses. Does that even apply if you’ve lost crypto on an exchange? As we know, the history of crypto is riddled with exchange hacks?
Jason Tyra: 00:43:09
Well, it depends on the fact pattern. So a capital loss is different than a theft or a casualty loss. A theft or casualty loss under pre 2018 law was an itemized deduction. A capital loss has taken on a different part of the return, so you may have a case to make that you have a capital loss in an exchange failure as opposed to a casualty or theft.
Tyson Cross: 00:43:36
There’s actually a really interesting wrinkle here in the law that is maybe worth exploring more now that the casualty loss deduction is gone. And that’s when you can abandoned property and take a capital loss for the abandonment. And it’s something I haven’t looked into too closely yet, but it’s been on my list of things to do for clients who are in this situation. Because, you can actually abandoned property and take your capital loss. So how do you abandoned crypto that’s on an exchange that folded. I mean there’s a lot of mechanics there that become difficult to navigate, but it’s at least maybe a potential option down the road worth exploring for clients who lose funds on these exchanges and are sort of desperate to get some kind of benefit out of that for tax purposes at least.
Laura Shin: 00:44:21
Let’s talk also about wash sales. Can you define what that is and describe how the ears treats wash sales of crypto assets?
Jason Tyra: 00:44:29
Sure. The short answer is that wash sale rules do not apply to virtual currencies. And to expand on what the wash sale rules say, you cannot purchase an asset that is the same as, or substantially similar to one that you have disposed plus or minus 30 days. If you look at the wash sale rules, they specifically apply to securities and notice 2014-21 does not lump virtual currencies in with securities. Securities have specific attributes that are not shared by virtual currencies. One of which is that you have a counter party with a security. You really don’t with a virtual currency, A security guarantees you some sort of rights or privileges. Or, has obligations associated with it. Not so with virtual currencies. At least in my opinion, virtual currencies are not even similar to securities. I think they’re unlikely to fall under the wash sale rules.
Laura Shin: 00:45:38
Taking that in conjunction with what we were saying before about how crypto to crypto trades are not like kind exchanges does that mean if I sell my XRP at a loss a or trade it for let’s say ether which then goes up, then I can have both a loss that I can deduct. But, then later I have the capital gain?
Tyson Cross: 00:46:05
Yes. In that situation, those were separate transactions, assuming you don’t treat them as like kind. If you treat them as like kind there would be no gain or loss on the transaction. So what Jason is saying and I agree with him is that crypto is not covered by the wash sale rules as they’re currently drafted. And, if crypto continues to grow in widespread adoption, that’ll change eventually. You know there’s a reason why the wash sale rules exist is to prevent you from harvesting tax losses when you have positions that have dropped in value. You could just sell it, trigger the tax loss, which will offset your other gains for the year. And then you buy back the position again. And your investment position has not changed yet. You have this favorable loss that can offset other sources of gains on your tax return. That’s what the wash sale rules are trying to prevent.
Tyson Cross: 00:46:56
I’ll point out one thing from the law standpoint. There’s this stick the IRS keeps in its back pocket called the economic substance doctrine. And it says that any transaction that lacks economic substance apart from the tax benefit can essentially be disregarded by the IRS. So when I’m talking to clients about wash sale rules, I caution them because yes, in theory you could have a position that goes negative. You could sell it to trigger the tax loss and then buy it right back in a moment later. In theory the wash sale rule or specifically the wash sale rule would not apply. However that type of transaction is at risk under the economic substance doctrine. Because your economic position has not changed. It’s identical. And the only reason you did that transaction was for the tax benefit of harvesting the loss. So the IRS could disregard that.
Laura Shin: 00:47:51
Right. But what I was asking about was if you exit a poor performing crypto asset, like let’s say XRP has dropped recently, so let’s use that as an example. Let’s say I trade that for something like Ether that has gone up probably over the same time period. Then I do actually benefit from both the loss as well but then obviously I still have the gains.
Tyson Cross: 00:48:21
In that situation, your position has changed and that’s what the wash sale rule was looking at. You know, you switched to a different crypto. So that loss you incurred on ripple in effect was real. You changed positions, you realize the loss, you acquired ether. Your position has changed. Not only does that transaction not fall within the wash sale rule simply because cryptos aren’t securities, but also from a economic substance standpoint, you have economic substance in that transaction because you did actuallychange your position from going from ripple to ether.
Laura Shin: 00:48:53
So for 2018, what habits do you recommend crypto enthusiasts pickup at the beginning of the year, so as not make their taxes a year from now too painful?
Tyson Cross: 00:49:07
I’m sure, Jason hears the same thing. I talked to clients who are aghast that every exchange of crypto to crypto is a taxable event. That fact still doesn’t seem to have permeated the crypto community. So one of the best things you can do aside from simple things like keeping good records, is be a little more deliberate about the exchanges you have. Sometimes a users would just kind of swapping in between Crypto is almost for fun and they don’t realize that they’re really creating quite a mess for their tax return.
Laura Shin: 00:49:35
When you say to keep good records, it would be what you paid for it, the date, the amount you sold it for, what else would you want to log on such a spreadsheet?
Tyson Cross: 00:49:46
That’s the most important thing, the date, the quantity, the coin you gave up the coin you got back, the price, and we’ve talked about the records exchanges will keep for you. And generally those are fine to use. I mean, if you’re doing a significant amount of trading practically speaking, you can’t really manually keep those types of records anyways. You’re going to have to rely on the exchange reports. But, I do run into people all the time who’ve done trades through shape shift or other decentralized exchanges that don’t provide transaction reports. And in that situation, that’s where it falls on you to keep track of those. Same thing with making an ICO investment. Any of those exchanges that occur off of a normal exchange platform, you’re going to have to keep manually in order to accurately calculate your tax return.
Jason Tyra: 00:50:29
I just want to expand on that a little bit because I think Tyson hit the nail on the head. Be a little more deliberate. The number one issue that we have had with clients in the past especially this past year, we have clients that say, “I didn’t know. I didn’t keep any records. What do I do?” The short answer is, well, you’re already out of compliance. There’s not really anything you can do except try and report something and just being a little more deliberate about your activity. Being aware of what you’re doing and what is expected of you under the law can go a long way to avoiding headaches in the future.
Laura Shin: 00:51:09
Are things any easier or more streamlined for people if they use an LLC to trade?
Jason Tyra: 00:51:13
I don’t think so. No.
Tyson Cross: 00:51:13
No, I don’t think so either.
Laura Shin: 00:51:17
What do you recommend, either tax accounting software or any other programs that you think people could use to help with this headache?
Tyson Cross: 00:51:30
The big two that are out there right now are bitcoin.tax and cointracking.info. And their tools that help you essentially conducts the calculations you need to do in order to figure out your capital gains with crypto. They’ll run first out first in or last in first out or whatever basis message you choose in order to calculate your gains. I’m not aware of any others. They seem to work fine from what I hear. I can’t personally vouch for either, but, those are definitely the most popular. I don’t know if Jason knows of any others.
Jason Tyra: 00:52:04
Those probably are the two that are in the widest use. There probably are others, but those are the two that we use and we found that they worked very well.
Laura Shin: 00:52:17
It sounds to me like obviously regulation in this area has not been said. There’s a lot of work that needs to be done in clarifications to be made. I’ve heard about this cryptocurrency fairness in taxation act. I wanted to have you describe what that is and whether or not you think it’s a good idea. But then also, describe whether or not you think there are any other countries out there that have taken either a much more progressive or conservative stance on crypto taxes and whether or not there are any policies that you see are being instituted abroad that you think we should be adopting here in the US.
Tyson Cross: 00:52:51
Was that the bill that came up last year? I don’t think anything happened with it, correct?
Jason Tyra: 00:52:57
I love talking about the crypto currency tax fairness act because it’s just such a bizarre bill. if you look at it, essentially what the bill said was that transactions with a gain of less than, I think it was $600 would be exempt from taxation. This would basically engineer a loophole for anyone who could write a script that would ensure that no lot of coins ever had a gain of more than $600 to just never pay taxes ever. I think the idea was to promote virtual currencies as a means of exchange so that you could reasonably go and pay for a cup of coffee or whatever without having to report that. It’s never going to become law because it’s just too easy to exploit in a way that makes virtual currencies untaxable.
Tyson Cross: 00:53:58
Yeah. I completely agree.
Laura Shin: 00:54:00
Are you seeing anything happening abroad that you think would be maybe a way for us to go here in the US?
Tyson Cross: 00:54:07
We have a potential solution to this issue and it’s the way the taxes are done for foreign currency exchange. Foreign currency, if you trade it as an investment, it is taxable – capital gains. If you use it in a personal use transaction. I believe the threshold is $200 of gain, anything less than $200 is not a taxable, not reportable. And that’s why you can go on vacation to Europe and use euros to buy a cup of coffee and not have any concern about gain or loss. And even if you come back to the US and sell your euros back at the bank, you don’t have to worry about gain or loss. That’s what we need. I don’t think we need necessarily to treat virtual currency, as currency. But, we at least need to apply a similar tax regime where you have this exception for personal use transactions. Which is much narrower than the bill that was proposed last year. And, I think would adequately address the issue that Jason correctly brought up that if it’s just a flat dollar exemption, there’s too much opportunity for manipulation of that.
Jason Tyra: 00:55:13
I think the problem with that though is it’s not really clear that the use case for virtual currency as a replacement for fiat, that that’s really expanding. I mean, I’ve been in the space for close to five years. I think Tyson, you’ve been around just as long as I have, if not a little longer. And, the kind of golden age of that was 2013, 2014 when it was cheap to transact in virtual currency and specifically bitcoin. It kind of seemed like that the number of merchants that were accepting it was increasing. And, we’ve seen a lot of pullback in the last several years from that. I don’t think that there’s this vast community of people out there that’s just waiting on the edge of their seat for the day when they can use bitcoin to pay for a cup of coffee every single day. If there was, then they seem to have evaporated over time.
Tyson Cross: 00:56:10
And if I can point out one thing, and maybe it’s a little tangential, but, crypto currency right now, as we’ve shown by just discussing the tax elements is outside the existing regulatory and legal framework and it doesn’t fit well with any of the current rules. I’m sort of surprised at this point that we haven’t seen more effort in the community to put forward a lobbying effort in Congress in order to get things like a personal use exemption or other clarification on points related to the regulation of crypto currency to make a better effort as far as lobbying goes to make those things happen. Maybe I’ve just overlooked it, but as far as I can tell, there’s not a very concentrated effort on that front. At this point now in 2018, I think it’s safe to say crypto is probably here to stay at this point. And so now maybe it’s the time to really start making an effort to get the legislation that we need to absolve a lot of these issues that are making the use and adoption of crypto currency difficult.
Laura Shin: 00:57:13
Well maybe that’s something that Coin Center, one of the advocacy groups, can work on. For listeners who have not heard that episode with Coin Center from season two or maybe it was season one actually. They were just amazing and really interesting and we got into all kinds of interesting discussion around ICO’s and stuff like that. To wrap up, what is the number one or biggest takeaway that you’d like listeners to know about crypto and taxes?
Tyson Cross: 00:57:40
I would say that the most important thing to remember is that every exchange is taxable. And that means that you have a burden as a taxpayer to keep track of your activity with crypto. And you can rely on exchanges to a degree, you know, assuming they don’t go under to report to your activity. But at the end of the day, the obligation is on you. And that’s an important duty that you need to make sure you’re meeting and that would imply keeping records of exchanges and trades that happen off of a exchanges and just making sure that you’re able to comply adequately with your tax reporting requirement.
Jason Tyra: 00:58:19
I guess a more positive spin on the lawyers comments. This is a really exciting time, I think for virtual currency. And for me at least, it’s been fun to see how many clients have really changed their lives over the past five years. And specifically in the past year. I have a client that is a checker at the grocery store and it probably has never made more than $30,000 in his life and made a million dollars last year trading virtual currency. That is a life changing event for this guy. So, you know with regards to tax, there’s no hundred percent tax rate and even if you’re in the top bracket this year, it’ll be 37 percent, you still get to keep what, sixty three cents out of every dollar that you make it’s too easy to just report your taxes and pay what you owe, and then keep the rest to try and dunk it and not meet your obligations. You’re probably going to be found out and in the end it’s going to mess it up for everybody.
Laura Shin: 00:59:30
All right, well, I’ve been speaking with Tyson Cross and Jason Tyra. it’s been fantastic having you both on as guests. Where can people get in touch with or see more of your work?
Tyson Cross: 00:59:45
I can be found at bitcointaxsolutions.com. I’m on twitter now. I’m new to twitter, but my handle was Tysonpcross. And, I’d love to catch up with anybody who wants to discuss crypto currency taxation.
Jason Tyra: 00:59:53
And you can find me a Tyracpa.com. I’m also on twitter at TyraCPA though I’m not so active.
Laura Shin: 01:00:02
Great. Well, thank you both for coming on the show. Thanks so much for joining us for this episode on crypto and taxes. To learn more about Tyson and Jason and to find previous episodes of this show with other innovators and the Blockchain and crypto space, checkout my Forbes page: forbes.com/sites/LauraShin. And also be sure to follow me on twitter @LauraShin. New episodes of unchained come out every other Tuesday. If you haven’t already. Rating, review or subscribe on Itunes or wherever you get your podcasts. If you liked this episode, share it with your friends on facebook, twitter, or linkedin. Unchained is produced by me, Laura Shin with help from Elaine and fractal recording. Thanks for listening.
