Foreign Nationals & Expats
Houston Tax Attorney
How are cryptocurrencies treated for federal tax purposes?
Despite the name, cryptocurrencies are not “currencies” at all for tax purposes. The IRS treats virtual currency as property (i.e., assets). General tax principles applicable to property transactions apply to purchase and sale of virtual currencies.
As an asset, the taxable income from the sale of a cryptocurrency unit is determined by subtracting the sales price minus the basis.
If purchased, the basis is the cost at with the units were purchased. If received as payment for goods or services, the basis is the fair market value of the virtual currency in U.S. dollars as of the date of receipt.
If mined, then 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 depends on whether the virtual currency is a capital asset in the hands of the taxpayer. For most individuals, it will be a capital asset. 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. Cryptocurrency dealers would therefore report ordinary gain or loss.
Cryoptocurrency transactions can be challenging, especially where there are numerous purchase and sale transactions. Unlike with U.S. securities accounts, cryptocurrency exchanges do not track your gain and loss, and it falls upon the investor to calculate those.
From U.S. based exchanges, you’ll likely receive a 1099-K but that will include your total proceeds but will provide no information regarding cost basis.
It is also important to note that a coin-to-coin trade is considered a sale or disposition.
Do international information reporting requirements (e.g. FBAR, 8938) apply to cryptocurrencies?
The FinCEN 114 (“FBAR”) requires U.S. persons who have financial interest in or signature authority over a foreign financial account to report such accounts on an FBAR to the Department of Treasury on a annual basis. Foreign financial accounts include bank accounts, securities accounts, and other financial accounts.
Cryptocurrencies purchased on foreign exchanges may be subject to FBAR and Form 8938 reporting requirements. There is currently no official guidance from the IRS that specifically requires cryptocurrency accounts to be reported on any international information forms. However, the IRS is not required to enumerate every possible type of account that falls into the purview of the FBAR reporting requirement.
Form 8938, filed with the individual’s U.S. tax return, requires taxpayers to report beneficial ownership in any foreign financial assets that exceed certain thresholds. Specified financial assets include:
(A) any stock or security issued by a person other than a United States person;
(B) any financial instrument or contract held for investment that has an issuer or counterparty which is other than a United States person; or
(C) any interest in a foreign entity (as defined in I.R.C. § 1473).
It is unclear whether FBAR and/or Form 8938 is required for cryptocurrency accounts.
Deferring gain through IRC section 1031 (like-kind exchanges)
For tax periods 2017 and earlier, it was possible (although difficult) to defer tax on the disposition of cyptocurrency through a like-kind exchange. However, the recent Tax Cuts and Jobs act limits the ability to apply IRC Section 1031 to real property only.
Cryptocurrency IRS enforcement efforts
In 2016 Coinbase was served with a John Doe summons to produce the records of U.S. account holders between 2013 and 2015. After almost a year of legal challenges, the scope of the summons was narrowed. However, Coinbase is still required to turn over information regarding some 9 million Coinbase transactions and nearly 14,000 accounts to the IRS. The IRS estimated that only 800 or 900 account holders actually reported their bitcoin sales during the periods covered by the summons.
It’s likely that taxpayer non-compliance identified from the Coinbase summons will be addressed through audits and criminal investigations. Depending on the IRS’ success in those cases, we’ll likely see additional enforcement efforts and perhaps additional John Doe summons issued to other crypto exchanges. Or in the case of foreign exchanges, the Justice Department would request summons enforcement pursuant to a tax treaty.
The IRS recently announced in a tax conference in New York City that its criminal investigators will soon be undergoing mandatory enforcement training. However, the task force would be primarily focused on prosecuting individuals who commit tax-related crimes using cryptocurrency.