Update: The IRS calls for the “specific identification” (SI) accounting method for use on sales of property, including intangible property (coin). IRS regulations for SI require “adequate identification” of lots sold on a contemporaneous basis, and I don’t think most coin traders comply with these rules. In June 2016, the AICPA asked the IRS if coin traders could use “first in first out” (FIFO) as an alternative solution, which the IRS permits for securities. Unless you comply with SI rules, I suggest using the FIFO accounting method for coin. (See Accounting Method Impacts Crypto Income Taxes.)
If you have multiple cryptocurrency (coin) trades, consider a trade accounting solution dedicated to coin transactions. The program should calculate taxable income and loss based on IRS rules for coin transactions. It should generate capital gains and losses reports to support Form 8949 and “other income” statements. The program needs to account for all coin transactions, including coin-to-currency trades, coin-to-coin trades, receipt of coin in a hard fork or split transaction, purchases of goods or services made with a coin, and mining revenue.
I reviewed two coin accounting solutions that fit the bill: Bitcoin.Tax and CoinTracking.Info. Both programs provide options for different outcomes and in general, stick with the default method to stay clear of potential IRS trouble. (See How Cryptocurrency Investors Can Avert IRS Attack).
Coin exchanges do not provide taxable income reports
Don’t look to your coin exchange for much help with tax reporting. They don’t keep cost-basis information and are unable to give the users online tax reports. A coin is not a “covered security” for Form 1099-B issuance, so coin investors and the IRS don’t receive a 1099-B.
Coin investors are responsible for generating their accounting and tax reports. With uncertainty on tax treatment due to lack of sufficient IRS guidance, many coin traders wind up under-reporting taxable income on coin transactions. In most cases, it may be inadvertent, but sometimes, it’s willful. Using accounting software shows an attempt to be compliant.
The IRS is pursuing coin investors
The IRS served a “John Doe” summons (the worst kind) to the most significant coin exchange, Coinbase, to obtain its customer list for investors and traders with coin transactions worth more than $20,000. The IRS calculated that less than 900 taxpayers reported capital gain or losses on coin transactions in 2015, an alarmingly small number.
With coin prices skyrocketing in 2017, the U.S. Treasury wants tax revenues — its share of the windfall profits. Perhaps this is the reason they labeled coin “intangible property” rather than currency. There wouldn’t be any taxable income or loss on the use of money.
I spoke with the owner of Bitcoin.Tax (BT), Colin Mackie, who described his program to me in detail. Here’s what I learned.
“Most coin exchanges allow a download of account history as a CSV file, and then BT imports it,” he said. “BT also has an API solution that works with some coin exchanges like Coinbase and Gemini, to download directly into BT.”
Mackie said the program produces various downloads for capital gains, such as Form 8949 PDFs, 8949 attachable statement, TurboTax import, TaxACT import, and plain CSV.
“For income, it’s a summary of income and mining per coin as a CSV,” he said. “For Section 1031 like-kind exchanges, it’s a statement of the appropriate lines from the Form 8824, one row per trade.”
The BT default method is to report capital gains and losses on coin-to-coin trades like trading Bitcoin for Ethereum. I suggest our clients use this default treatment to be compliant with IRS rules. The program offers an option to defer income and loss on all coin-to-coin trades by treating those trades as Section 1031 like-kind exchanges. If you select the like-kind exchange option, the BT program delays all taxable income or loss on these trades for the entire year until the user sells the coin for currency. Mackie said some accountants requested this option, but I strongly advise our clients against it. (See Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges.)
Mackie recommends BT users to pay careful attention to hard fork transactions, such as when Bitcoin distributed Bitcoin Cash.
“The coin exchange shows an addition to coin balances for the hard fork distribution, but some don’t include the new coin received in trade activity,” he said. “Sometimes BT picks it up automatically. Otherwise, it requires the user to add the new coin manually. The user can enter the new coin in as income using the daily price on the fork date. But, users also have the option to enter zero for cost basis.”
Sometimes a user doesn’t get a constructive receipt of the new coin, or the new coin doesn’t have a trading price on the day received. Report it as taxable income when accepted if you can determine it’s value. (See How To Report Bitcoin Cash And Avoid IRS Trouble.) BT offers a wide selection of accounting methods, which it calls basis methods, and I am not sure all of them will pass muster with the IRS. BT offers FIFO, LIFO, average cost, and specific identification.
Mackie says the specific identification method “uses strategies, so the user may select the lowest cost, highest cost, or closest cost, where the program finds the best match to minimize capital gains.” That sounds like too much cherry picking after year-end. I think users should use acceptable accounting methods and select them in writing before the year commences.
I suggest our clients use FIFO to stay out of harm’s way with the IRS. This program feature of greater choice of basis method naturally leads to more income deferral and that will attract more IRS attention.
All that being said, I think BT is an inexpensive accounting solution that can work well for American taxpayers, provided they stay clear of the non-compliant options to defer income. Be sure that the program captures all transactions from the coin exchange.
BT is free up to 100 transactions, and it charges $19.95 per year when users exceed 100 entries.
CoinTracking.Info is another accounting solution to consider. I spoke with CoinTracker founder and CEO Dario Kachel to learn more about this program. According to Kachel, CoinTracking is the only service with current and historical prices for all 4,878 coins on the market.
RG: Does CoinTracking (CT) generate a capital gains and losses report for American coin investors in compliance with U.S. tax law?
DK: Yes, it does. CoinTracking creates U.S. compliant tax reports such as Capital Gains And Losses on Form 8949, Other Income Reports, Gift and Donation Reports, Lost and Stolen Reports, and Closing Position. Reports can be exported in many formats like Excel, CSV, PDF and even in standard forms like Form 8949, Statement for the IRS, TaxACT, and TurboTax.
RG: Does CT account for all coin transactions, including coin-to-currency trades, coin-to-coin trades, receipt of coin in a hard fork or split transactions, and each time a coin investor purchases goods or services using a coin?
DK: Yes. We support all your mentioned transactions, which is necessary for a correct capital gains report. Also, we handle mined coins, income (e.g., a salary in cryptos), gifts, donations, and lost or stolen coins.
RG: On coin-to-coin trades, like trading Bitcoin for Ethereum, does CoinTracking report a capital gain on the imputed sale of Bitcoin?
DK: Yes it does. All coin-to-coin trades will be calculated based on the cost basis and the proceeds value of the cryptos at the time of the transaction converted in USD or any other FIAT currency.
RG: On coin-to-coin trades, does CT offer the user an option to use a “like-kind-exchange” to defer the capital gains income?
DK: The option for like-kind calculations on CoinTracking is already in progress, and we will release it in December 2017. But as you said, coin investors do not qualify for like-kind exchanges, and there are no other countries officially supporting like-kind calculations (that we know of at this moment).
RG: For coin forks or splits, does CT account for the receipt of the new coin and report its fair market value or initial trading price as income? Does the program report other income or capital gains income?
DK: There are two ways (for our program) to calculate forked coins. The easy way is to figure them with their fair market value. The other way is to set the cost basis of both coins on the date of the fork depending on the coin distribution. For example, the BTC/BCH split was a 90:10 split. This would mean, that all your new BCH coins would receive a cost basis of 10% of your BTC cost basis.
RG: In How To Report Bitcoin Cash And Avoid IRS Trouble, I suggest two options, too.
RG: Do you give the user the choice of accounting method after-the-fact, so they cherry pick which is best for them in a given tax year? (We frown upon that practice as pointed out in my last blog post, How Cryptocurrency Investors Can Avert IRS Attack.)
DK: Yes, users can change the accounting method as often as they like. We also provide an instant gain calculator, where users can estimate their gain/loss and tax even prior the sale of assets.
CT’s Website states that it offers the various accounting methods including FIFO, LIFO, HIFO, and LOFO.
CT is free to use for up to 200 transactions, and it charges $325 “for lifetime use,” when users exceed 200 entries. “CT also offers more imports than other providers, margin trades, lending and borrowed coins,” says Kachel.
Coin investors and traders face a minefield of IRS trouble on a wide selection of tax accounting issues. Non-compliance is rampant, and the IRS is on the case. Put your best foot forward by using one of these accounting solutions and don’t use the features that can get you into trouble like like-kind exchanges.
If you have questions, please contact us or another expert in coin taxation.