Category: Cryptocurrencies

Bipartisan Digital Asset Tax Bill Could Apply Wash-Sale and Section 475 Rules to Crypto

September 18, 2026 | By: Robert A. Green, CPA

A bipartisan digital-asset tax bill advancing in Congress could significantly change the federal tax treatment of cryptocurrency traders—and reverse the new 90% limitation on wagering-loss deductions.

On September 16, 2026, the House Ways and Means Committee voted 38–5 to advance an amended version of the Digital Asset Tax Certainty Act, H.R. 10357, for consideration by the full House. The committee approved Chairman Jason Smith’s substitute amendment before the final vote.

The bill is not yet law. The House and Senate must pass identical legislation, and the president must sign it. Nevertheless, several provisions could directly affect my recent articles on wash sales, §475 mark-to-market accounting, and prediction markets.

Crypto Could Become Subject to the Wash-Sale Rules

Direct cryptocurrency, such as Bitcoin, is generally treated as property for federal income tax purposes and is generally not considered stock or securities for purposes of the §1091 wash-sale rules. Crypto-related funds, securities, options, and derivatives may be subject to different rules.

The committee-approved bill would extend §1091 to traded digital assets, generally excluding assets specifically defined as qualified U.S. dollar stablecoins. If a taxpayer sold a covered digital asset at a loss and acquired substantially identical property within 30 days before or after the sale, the loss generally would be deferred and added to the replacement position’s tax basis.

The proposal also includes anti-avoidance provisions that apply to certain contracts, options, tokenized assets, and wrapped assets. These provisions are intended to prevent taxpayers from avoiding the wash-sale rules by switching temporarily into an economically equivalent digital asset or financial instrument.

Certain acquisitions would not trigger wash-sale treatment, including assets received in connection with transaction validation or supporting activities and certain regular or periodic acquisitions included in ordinary income.

If enacted, these changes could make tax accounting considerably more difficult for traders who use multiple exchanges, wallets, and accounts. Traders could be responsible for identifying replacement purchases even when the loss sale and subsequent purchase occur on different platforms.

For affected digital-asset dispositions before January 1, 2028, the bill would allow brokers to determine customer basis for reporting purposes without applying the new wash-sale rules. That broker-reporting relief would not eliminate the taxpayer’s obligation to apply the rules.

Traders could therefore need specialized accounting software to calculate wash-sale adjustments that do not appear on broker reports. Even after the transition period, broker reporting might not identify every taxpayer-level wash sale because broker rules generally focus on identical assets acquired in the same account, whereas the taxpayer rules can apply more broadly across accounts and platforms.

The committee substitute would apply the new wash-sale provisions to dispositions after September 14, 2026. That potentially retroactive effective date deserves close attention as the legislation moves through Congress.

The Joint Committee on Taxation estimates that extending the wash-sale rules to digital assets would increase federal revenues by approximately $1.7 billion over fiscal years 2027–2036.

See my recent article, Wash-Sale Losses for Traders: How to Avoid Phantom Income and Costly Tax Traps.

Section 475 MTM Could Become Available to Digital-Asset Traders

The bill would permit qualifying dealers and traders in covered digital assets to elect §475 mark-to-market accounting.

Under current law, §475 expressly addresses securities and commodities but does not explicitly address digital assets. Whether particular digital assets qualify under the existing definitions remains uncertain. We have taken a conservative position and have not treated §475 as available for direct cryptocurrency trading.

The proposal would create a clearer election framework for qualifying dealers and traders in covered digital assets.

Mark-to-market accounting generally treats covered open positions as though they were sold at fair market value on the last business day of the tax year. If enacted, qualifying crypto traders could mark eligible positions to market at year-end and generally report the resulting gains and losses as ordinary items.

Potential benefits could include:

  • Ordinary gain-or-loss treatment on covered business positions
  • Exemption from wash-sale loss adjustments on those positions
  • Relief from the $3,000 annual capital-loss limitation
  • Potential qualification of net §475 ordinary income for the 20% qualified business income deduction, subject to the specified service trade or business limitations

These benefits would not apply automatically to every active crypto trader. The taxpayer would still need to qualify for trader tax status, make the §475 election correctly, identify any excluded investment positions, and comply with the final transition procedures.

The bill’s definition of covered positions would include eligible digital assets and certain related digital-asset positions and hedges.

Special Transition Rules Could Affect 2026 and 2027

The new digital-asset §475 provisions would apply to taxable years beginning after enactment.

For taxpayers making the new election for the first eligible year beginning after enactment and before January 1, 2028, special transition rules would address preexisting positions, the initial mark-to-market adjustment, and certain prior-year wash sales.

The proposal would spread the initial net §481 accounting adjustment over four years and provide a special 30-day identification period for covered positions held at the beginning of the first election year. Pre-election built-in gains and losses would not automatically become ordinary; their prior character generally would be preserved in the transition adjustment.

The 30-day period concerns identifying positions, not the deadline for making the §475 election.

The bill also provides conditional relief for certain preceding-year digital-asset wash sales involving transactions made in the ordinary course of the taxpayer’s dealer or trader activity.

If the bill is enacted in 2026, a qualifying calendar-year taxpayer’s §475 election for 2027 could therefore affect the treatment of some 2026 digital-asset wash sales. This is conditional relief with specific requirements, not a blanket exemption for 2026 cryptocurrency losses.

JCT estimates that the dealer-and-trader mark-to-market provisions would increase federal revenues by approximately $2.3 billion over fiscal years 2027–2036. That is a ten-year federal budget estimate, not a prediction of the tax result for an individual trader.

Full Wagering-Loss Deductions Could Return

H.R. 10357 also incorporates the FULL HOUSE Act, which would repeal the One Big Beautiful Bill Act’s new 10% haircut on wagering-loss deductions.

If enacted as written, the bill would restore the prior rule allowing wagering losses and related expenses to offset wagering winnings without the 10% haircut. Losses still could not exceed wagering gains.

The provision would apply to taxable years beginning after December 31, 2025, making the change effective for 2026.

This could affect prediction-market participants if their contracts are ultimately classified as wagering transactions. However, the bill does not establish a blanket tax classification for prediction-market contracts. It does not resolve whether particular contracts should be treated as capital transactions, wagers, swaps, §1256 contracts, or another type of property.

See my analysis, How Are Prediction-Market Trades Taxed—Capital Gains, Gambling, or Something Else?

What Happens Next?

The 38–5 vote demonstrates bipartisan support in the committee, but committee approval is only one step in the legislative process.

Digital-asset traders should continue to apply current law and should not treat the proposed wash-sale expansion or the new digital-asset §475 election framework as enacted law. Nevertheless, traders should maintain detailed transaction records and monitor legislation, as the proposed effective dates could affect transactions occurring before enactment.

Sources: committee-approved substitute to H.R. 10357, House Ways and Means Committee markup record, and Joint Committee on Taxation revenue estimate.

Research and drafting assisted by AI tools, used under my direction; I verified all citations and am responsible for the analysis and conclusions.

Digital Asset Tax Accounting

August 14, 2025 | By: Robert A. Green, CPA

Accurate accounting for digital assets is critical for U.S. tax compliance and effective financial strategy. This post covers taxable events, basis and gain/loss calculations, accounting methods, wash sale rules, and key considerations.

Taxable Events for Digital Assets
Taxable income, gains, or losses can result from:

  • Selling for fiat currency (e.g., Bitcoin for U.S. dollars)

  • Exchanging for property, goods, or services (e.g., buying a car with Bitcoin)

  • Swapping one digital asset for another (e.g., Bitcoin for Ether)

  • Receiving digital assets as payment (e.g., selling consulting services for Bitcoin)

  • Acquiring new assets through hard forks (e.g., Bitcoin Cash). Note: a hard fork alone, without an airdrop, does not trigger income recognition.

  • Earning through mining or staking (e.g., staking rewards for proof-of-stake; mining coins for proof-of-work)

  • Receiving assets via an airdrop (e.g., distribution of free tokens)

  • Any other disposal of a digital asset interest.

Because virtual currency is considered property under IRS rules, gains or losses must be recognized whenever it is exchanged for goods or services. Income recognition occurs when the taxpayer has dominion and control over the cryptocurrency.

Determining Basis
The basis of purchased or exchanged digital assets is generally the amount paid or the FMV of property received, plus any allocable transaction costs. Assets received for services have a basis equal to the FMV of those services.

Amount Realized
Under Reg. 1.1001-7, the amount realized includes cash received, FMV of property or debt instruments received, and FMV of services received, less allocable transaction costs. Using digital assets to pay these costs is an additional taxable disposition. FMV is measured at the date and time of the exchange or disposition.

Digital Asset Transaction Costs
Transaction costs—fees, transfer taxes, commissions, and similar amounts—add to the basis when acquiring an asset and reduce the amount realized upon disposition. For asset-for-asset trades, all costs are allocated to the disposed asset.

Accounting Method
Specific identification is allowed if you can substantiate the basis of units sold. Identification can be made using unique digital identifiers or detailed transaction records showing acquisition and disposition dates, basis, FMV, and proceeds. FIFO (first-in, first-out) and LIFO (last-in, first-out) are also acceptable if applied consistently. Changing an accounting method typically requires consent from the IRS via Form 3115.

Wash Sale Losses
Digital assets are generally not subject to wash sale rules because they are treated as property rather than securities. However, tokenized securities, other dual-classification assets meeting the definition of a security, and Bitcoin Futures ETFs structured as Registered Investment Companies (RICs) are subject to wash sale rules.

Like-Kind Exchanges (Pre-2018)
IRS Legal Memorandum 202124008 concluded that bitcoin, ether, and litecoin are not like-kind property under IRC Sec. 1031. After 2017, like-kind exchange rules apply only to real property. Our firm warned against using like-kind exchanges for crypto—and we were correct.

Nonfungible Tokens (NFTs)
NFTs, representing items like collectibles, art, or in-game assets, are generally taxed as property, with gains or losses recognized at sale or exchange. Some NFTs may be subject to the 28% collectibles rate. Active trading by professional traders is rare, but tracking basis, holding period, and applicable rates is essential.

No Loss Deduction for Cryptocurrency’s Substantial Decline in Value
Cryptocurrencies do not qualify as securities under IRC Sec. 165(g)(2), so the capital loss deduction for worthless securities does not apply. In IRS CCA 202302011, the IRS addressed this issue for cryptocurrencies by denying capital losses arising from a substantial decline in value.

In short, a holder generally needs either a sale/exchange/spend or a clearly documented abandonment action that permanently surrenders the asset with no value received, to have an affirmative disposition supporting a crypto loss.

IRS Resources
The IRS provides a dedicated Digital Assets page with reporting guidance and FAQs. Visit www.irs.gov and search for “digital assets.”

Using Software for Compliance
Tax-compliant accounting software for U.S. taxes can help traders and investors download transactions from all wallets, exchanges, and other intermediaries, ensuring complete and accurate reporting. I will cover this in more detail in our upcoming post on Digital Asset Tax Accounting Software.

Conclusion
Proper U.S. tax compliance requires selecting an IRS-compliant accounting method, using software that can download and reconcile digital asset transactions, and maintaining accurate records. Covering taxable events, basis determination, gain/loss computation, accounting methods, wash sale rules, and loss limitations is essential to avoiding costly tax issues and ensuring accurate reporting.

See related sections below:

Digital Asset Tax Accounting Software Solutions

Accurate digital asset accounting demands reliable, U.S. tax-compliant tools. This post outlines essential software features for U.S. taxpayers, explains why compliance is substantial, and demonstrates how the right platform can simplify tax reporting.

Why Software Matters
Digital asset traders and investors frequently transact across multiple wallets, exchanges, and decentralized finance (DeFi) platforms. Manually tracking each purchase, sale, swap, and staking reward is tedious and prone to error. The right accounting software automates transaction imports, calculates gains/losses, and ensures compliance with IRS rules.

Key Features to Look For

  • U.S. tax compliance: Accurately applies IRS rules on gains/losses, taxable events, and reporting.

  • Automatic transaction downloads: Connect to all wallets, exchanges (centralized and decentralized), and intermediaries.

  • Multiple accounting methods: Support for FIFO, LIFO, and specific identification.

  • Complex transaction handling: Correctly process staking rewards, mining income, airdrops, NFTs, and hard fork distributions.

  • Wash sale rule logic: Apply or exclude wash sale rules as appropriate (e.g., tokenized securities vs. standard crypto).

  • IRS-ready reports: Generate Form 8949, Schedule D, and other required forms.

Integrating Software into Your Workflow
Choose a platform that consolidates all your transactions, reconciles records, and produces precise exportable reports for your CPA or filing software. Automatic transaction downloads help ensure every income event and gain/loss is captured.

Looking Ahead
Our next post will review top digital asset tax accounting software for U.S. taxpayers, including side-by-side comparisons of features, costs, and compliance capabilities.

Conclusion
U.S. tax-compliant accounting software protects against costly mistakes, reduces IRS audit risks, and streamlines reporting—freeing traders and investors to focus on strategy while staying compliant.

Comparing Digital Asset Tax Accounting Software Solutions

Selecting a U.S. tax-compliant digital asset accounting platform is essential for accurate reporting and minimizing audit risk. This post compares leading vendors on features, compliance, and suitability for U.S. taxpayers.

Why Software Choice Matters
Tracking trades across multiple wallets, exchanges, and DeFi platforms manually is impractical. The right software automates imports, accurately applies IRS rules, and produces Form 8949 and Schedule D-ready reports.

Evaluation Criteria

  • U.S. tax compliance: Aligns with IRS rules for gains, losses, and taxable events.

  • Transaction import: Connects to centralized and decentralized exchanges, wallets, and intermediaries.

  • Accounting methods: Supports FIFO, LIFO, and specific identification (IRS approval needed for changes).

  • Transaction coverage: Handles staking, mining, airdrops, NFTs, and hard forks.

  • Wash sale rules: Distinguishes tokenized securities from other digital assets.

  • Reporting: Generates accurate, IRS-ready forms.

Vendor Comparison Table

Vendor U.S. Tax Compliance Integration Coverage Accounting Methods Specialty Features Best For
CoinTracking Yes Wide (CEX, DEX, wallets) FIFO, LIFO, Specific ID Detailed analytics, custom reports High-volume traders
Koinly Yes Extensive, easy setup FIFO, LIFO, Specific ID Simple UX, competitive pricing Casual traders
CoinLedger Yes Good CEX & wallet coverage FIFO, LIFO, Specific ID Fast imports, U.S.-focused U.S. compliance-focused users
TokenTax Yes Wide integrations, manual support FIFO, LIFO, Specific ID CPA review, advanced features Complex portfolios
ZenLedger Yes Strong DeFi support FIFO, LIFO, Specific ID NFT tracking, IRS audit help DeFi/NFT traders

Recommendations
Casual traders may prefer Koinly or CoinLedger. High-volume or complex DeFi users might opt for CoinTracking or TokenTax. Choose a solution that supports your transaction types and integrates with all your platforms.

Conclusion
The correct tax software simplifies compliance and reduces errors. In our next post, we’ll provide practical tips for importing transactions from all wallets and intermediaries—ensuring complete records before tax season.

Practical Tips for Importing Digital Asset Transactions
Ensuring Complete Records Before Tax Season

Introduction


Accurate digital asset tax reporting starts with complete transaction records. Whether you’re a casual investor or a high-volume trader, importing data from every wallet, exchange, and intermediary is essential for avoiding errors, omissions, and IRS scrutiny.

Why Comprehensive Imports Matter


Many traders use multiple centralized exchanges (CEXs), decentralized exchanges (DEXs), wallets, and DeFi platforms. Missing even a single transaction can throw off cost basis calculations, misstate gains or losses, and lead to discrepancies between your return and any 1099 forms the IRS receives.

Step 1: Inventory All Sources


List every platform where you’ve held or transacted digital assets:

  • Centralized exchanges (e.g., Coinbase, Kraken)

  • Decentralized exchanges (e.g., Uniswap, SushiSwap)

  • Custodial and non-custodial wallets

  • DeFi protocols, yield farms, and staking platforms

  • NFT marketplaces

  • On-chain transfers between your own wallets

Step 2: Use API and CSV Imports


Whenever possible, connect via API to ensure automatic, recurring imports. If APIs aren’t available, download and save CSV files for all transactions. Keep backups—many platforms limit historical downloads.

Step 3: Match Transfers and Avoid Duplicates


Transfers between your own wallets or exchanges shouldn’t be treated as taxable events. Good software should recognize these and prevent double-counting. Manual review may still be required for accuracy.

Step 4: Reconcile With Blockchain Data


Some wallets or exchanges may omit small transactions or older history. Cross-check with blockchain explorers (e.g., Etherscan, Blockchain.com) to ensure no activity is missed.

Step 5: Include All Transaction Types


Import more than just buys and sells:

  • Staking and mining rewards

  • Airdrops

  • Hard fork distributions

  • NFT mints and sales

  • Token swaps on DEXs

Step 6: Keep Year-Round Records


Don’t wait until tax season. Download or sync transactions regularly to reduce the risk of missing or inaccessible data.

Software Advantage


Modern tax accounting software automates imports, matches transfers, and applies IRS rules—saving hours of manual work. The right solution ensures that all taxable events are captured and classified correctly.

Conclusion


Comprehensive transaction imports are the backbone of accurate digital asset tax accounting. Our next step is to look at best practices for data reconciliation and audit preparation—ensuring you can substantiate every number on your tax return.

Best Practices for Digital Asset Data Reconciliation and Audit Preparation

Introduction


Once you’ve imported all your digital asset transactions into tax accounting software, the next step is ensuring the data is accurate, complete, and ready to stand up to IRS scrutiny. Proper reconciliation and organized records not only make tax filing smoother—they are critical for defending your return in the event of an audit.

1. Reconcile Against All Sources

  • Compare software-imported data to original exchange CSVs, wallet histories, and broker statements.

  • Verify transaction counts and totals match across all sources.

  • Pay special attention to missing or duplicate transactions from decentralized exchanges or manually entered trades.

2. Track Adjustments and Corrections

  • Maintain a log of any edits made to imported data, noting the reason and source documents.

  • Avoid overwriting raw imports—keep a clean, original file for reference.

3. Preserve Supporting Documents

  • Store PDF or CSV copies of exchange and wallet histories for every tax year.

  • Save staking reward logs, airdrop announcements, and transaction receipts in a secure, organized folder system.

4. Align with IRS Requirements

  • Ensure basis and amount realized are correctly computed per IRS rules.

  • Keep documentation showing how you applied FIFO, LIFO, or specific identification (including private/public key records when needed).

Conclusion


Meticulous reconciliation and documentation are your best defense against costly IRS adjustments. In our next post, we’ll explore digital asset audit readiness, including what the IRS looks for and how to prepare before they knock on your door.

Digital Asset Audit Readiness: Preparing Before the IRS Knocks

Introduction


With the IRS increasing its focus on digital assets, audit readiness is no longer optional—it’s a must. Whether you trade Bitcoin, NFTs, DeFi tokens, or all of the above, being able to substantiate every figure on your return is the foundation of a strong defense.

1. Understand What the IRS Looks For

  • Transaction completeness – The IRS will expect that all taxable events have been reported, from trades to staking rewards to airdrops.

  • Matching totals – Gains, losses, and income on your return should match what’s shown in your supporting records.

  • Proper valuation – Fair market value must be determined consistently using reliable sources.

2. Maintain Evidence of Every Trade

  • Keep raw CSV exports from every wallet, exchange, and broker—don’t just rely on your tax software output.

  • Save blockchain transaction hashes and screenshots for key transactions, especially large ones.

  • Store staking logs, airdrop announcements, and records of hard forks (e.g., Bitcoin Cash split from Bitcoin).

3. Document Your Accounting Method

  • If using FIFO, LIFO, or specific identification, keep written confirmation of your chosen method and the basis for changes.

  • For specific identification, maintain detailed acquisition and sale records per IRS FAQ A40.

4. Organize Records Year-by-Year

  • Create a dedicated folder for each tax year containing raw data, reconciled reports, and a copy of your filed return.

  • Include notes explaining any unusual transactions or one-time events—your future self will thank you.

5. Use Technology to Your Advantage

  • Choose U.S. tax-compliant software that supports audit-friendly exports and immutable data logs.

  • Some platforms offer audit assistance or CPA review—worth considering if you have complex transactions.

Conclusion


Audit readiness starts long before you get a notice from the IRS. With complete, well-organized, and verifiable records, you can respond quickly and confidently, reducing both stress and risk. In our next post, we’ll cover real-world IRS digital asset audit scenarios and the strategies that worked for taxpayers.

Digital Asset Audit Scenarios: How the IRS Is Targeting Crypto

Introduction


With digital asset oversight ramping up, understanding real-world IRS actions offers critical insights. From warning letters to full criminal investigations, taxpayers need to know what triggers audits and how the IRS is leveraging blockchain data to enforce compliance.

1. Blockchain Analytics in Enforcement

The IRS has significantly boosted enforcement through digital asset casework. From 2018–2023, Criminal Investigation handled 390 virtual currency cases—with 224 resulting in prosecution. Blockchain analytics tools helped trace illicit activity, proving highly effective in investigations.

Virtual Currency Tax Compliance Enforcement Can Be Improved 

2. Surge in Warning Letters

Recently, taxpayers have seen a dramatic increase in IRS warning letters (Letters 6174 and 6174‑A)—up 750% over two months—alerting them to potential discrepancies between their returns and emerging Form 1099‑DA data.

3. Operation Hidden Treasure & Blockchain Tracing

The IRS’s Operation Hidden Treasure seeks crypto underreporting. Using tools from analytics firms like Chainalysis, the IRS can now trace transactions across blockchains—even linking wallet addresses to real individuals.



4. Focus on Complex Portfolios & High-Net-Worth Taxpayers

New audit teams and AI-driven methods target returns with digital assets, especially for high-income individuals and complex partnership structures. Returns combining crypto holdings with business deductions are now common audit targets.

5. Audit Triggers & Case Outcomes

IRS audits of crypto often stem from mismatches between income reported and exchange data reported via Form 1099‑DA. Cases have involved large unreported gains and tax miscalculations—leading to significant penalties when accurate records weren’t maintained.





Moreover, any discrepancy, even from routine trades being miscategorized, can trigger civil audits or deeper review.

Summary Table

Audit Trigger IRS Mechanism Real-World Impact
Warning letters (Letters 6174, 6174-A) Form 1099-DA cross-checking Taxpayers urged to amend reporting
Blockchain tracking Analytics tools & John Doe summons Identifies unreported activity
High complexity & high net worth AI-powered audit selection Increased audit rates for wealthy portfolios
Mismatched transaction reporting Form 1099-DA vs. taxpayer filings Triggered full IRS examinations

Bottom Line


The IRS is no longer passive on crypto enforcement. From aggressive data analytics to proactive audits of digital asset portfolios, the message is clear: accurate records and thorough reporting are essential.

How Taxpayers Successfully Navigated Crypto Audit Challenges

Introduction


IRS scrutiny of digital asset transactions is intensifying, but audits are survivable—if you understand the rules, maintain meticulous records, and respond strategically. Here’s how taxpayers have turned potential disasters into manageable outcomes.

1. Proactive Recordkeeping Pays Off

Taxpayers who kept complete transaction histories—downloaded from exchanges, wallets, and DeFi platforms—were able to substantiate cost basis and holding periods.

  • Key practice: Export transactions regularly in CSV or API format to avoid losing access when platforms shut down or change data retention policies.

  • Result: Provided auditors with a clear, reconciled ledger, shortening the audit timeline.

2. Matching IRS Data with Your Records

In multiple cases, the IRS audit began with discrepancies between Form 1099-K/1099-DA data and the taxpayer’s return.

  • Solution: Taxpayers reconciled every transaction in IRS records against their own logs, identifying where transfers between wallets had been mistakenly treated as taxable sales.

  • Outcome: Adjusted the IRS’s working papers, reducing or eliminating proposed tax due.

3. Demonstrating Non-Taxable Events

Some taxpayers faced assessments for events the IRS initially classified as taxable—such as wallet-to-wallet transfers or hard forks without airdrops.

  • Defense: Citing IRS Rev. Rul. 2019-24, they showed that no income is recognized until dominion and control is established.

  • Impact: Removed substantial amounts from proposed taxable income.

4. Leveraging Professional Representation

In several high-value cases, tax professionals—especially those versed in digital asset law—helped frame responses, submit organized exhibits, and negotiate with revenue agents.

  • Advantage: Reduced penalties through reasonable cause arguments, and in some cases, secured “no change” audit results.

5. Using Forensic Tools to Fill Gaps

Where transaction data was incomplete, specialized blockchain forensics tools reconstructed histories using public ledger data.

  • Outcome: Taxpayers could prove their reported gains were correct, even when exchange records were no longer available.

Conclusion


Success in a crypto audit comes down to preparation and precision. Keep every transaction documented, understand IRS classifications of taxable events, and don’t hesitate to get expert help when the stakes are high.

Digital Asset Trading Explained: Tax Rules For Crypto, ETFs, Futures, Options, And Tokens

August 11, 2025 | By: Robert A. Green, CPA | Read it on

Update — October 6, 2025: Senate Finance Committee Hearing (October 1)

Lawmakers and industry witnesses told the Senate Finance Committee that U.S. tax rules for digital assets remain unclear and burdensome. Members cited the need for practical guidance beyond the status quo (crypto as “property”), even as recent steps like the GENIUS Act’s limited exemption for certain stablecoin payment transactions from gain/loss reporting were noted as progress.

De minimis exemption proposal. Several witnesses urged Congress to create a small-transaction safe harbor (similar to the foreign-currency rule) so routine purchases (e.g., coffee, transit) wouldn’t trigger gain/loss reporting. Others warned that any relief should be tightly scoped (by amount and/or frequency) to prevent abuse and avoid new tracking headaches.

Staking and mining. Policy groups argued block rewards should be taxed only upon disposition (sale/exchange), analogizing to self-created property. Other experts defended the current approach: rewards are ordinary income when the taxpayer has dominion and control, with a separate capital gain/loss on later disposal. The Committee highlighted the need for consistent treatment across domestic and offshore providers.

What this means now. No immediate change to filing obligations. Crypto remains property for federal tax purposes; the GENIUS Act’s stablecoin payment relief is narrow. Keep robust records, monitor proposed legislation on de minimis relief and reward timing, and watch for IRS/Treasury guidance that could refine reporting under Form 1099-DA.

Original Post August 11, 2025:

Digital assets can be traded in multiple forms, each with distinct tax treatment, regulatory oversight, and strategic considerations. Here’s a detailed breakdown:

  1. Spot Cryptocurrency – Direct ownership of coins like Bitcoin (BTC) or Ethereum (ETH), purchased via exchanges or wallets, taxed as property under IRS Notice 2014-21. Capital gains/losses are realized upon sale or exchange. Not subject to wash sale rules, enabling immediate repurchase for tax-loss harvesting. The Section 475 MTM election is not available, even for trader tax status (TTS), as Section 475 only applies to securities and/or commodities (futures).

  2. Bitcoin & Crypto Futures (CME) – CME Bitcoin (BTC) and Ether (ETH) futures are regulated, cash-settled futures contracts (RFCs) traded on a U.S. Qualified Board or Exchange (CME Group). They settle in cash, not the actual digital asset. Qualify for Section 1256 tax treatment — 60% long-term / 40% short-term capital gains, MTM annually on Form 6781 — and are exempt from wash sale rules. Example: $100,000 of gains on futures taxed at a 26.8% (top 60/40 blended tax rate) vs. 37% (top ordinary tax rate) results in a savings of $10,200 (10.2%).

  3. Bitcoin & Crypto Options on Futures (CME) – Options on CME-listed Bitcoin/Ether futures (including Micro BTC and Micro ETH) qualify for Section 1256 as non-equity options listed on a QBE: 60/40 capital gains, MTM annually, no wash sale rules. Only options traded on a QBE in the U.S., like the CME, qualify for Section 1256 treatment. Options traded on offshore platforms or non-regulated exchanges do not.

  4. Bitcoin Futures ETFs (e.g., BITO) – Structured as Regulated Investment Companies (RICs), these ETFs invest primarily in CME Bitcoin futures. Investors hold ETF RIC shares (securities) rather than direct futures positions. The ETF itself marks to market under Section 1256, resulting in a 60/40 gain split at the fund level. The investor benefits from the lower 60/40 tax treatment in the 1099-DIV’s allocation of short-term and long-term capital gains. The investor doesn’t file Form 6781 on these RIC shares.

    Bitcoin futures ETFs, structured as RICs (e.g., BITO), are securities for tax purposes and, therefore, are subject to wash sale loss rules, which can disallow losses when repurchased within 30 days. While the underlying CME Bitcoin futures are regulated futures contracts on a QBE, the ETF RIC “wrapper” changes the classification to RIC, a security.

  5. Spot Bitcoin ETFs (e.g., IBIT, FBTC) – Structured as exchange-traded grantor trusts, it’s a look-through vehicle. The underlying asset is considered property, so capital gains/losses are realized upon sale, with no wash sale rule or application of Section 475. 

    SPDR Gold Shares (GLD) is also an exchange-traded grantor trust. This means that when you own shares in these exchange-traded grantor trusts, you hold a direct, proportionate interest in the underlying asset—either bitcoin or physical gold—held in custody by the trust. Tax-wise, it’s similar to buying and selling spot Bitcoin (property) or physical gold (a collectible) directly. 

  6. Tokenized Assets – Are digital representations of real-world assets (such as stocks, bonds, real estate, or commodities) issued and tracked on a blockchain. The legal and tax treatment of these assets depends on whether they qualify as regulated securities under U.S. law.

    SEC-registered tokenized securities are subject to wash sale rules (or Section 475 for TTS traders only). In contrast, unregulated tokens are treated as property and not subject to wash sale rules or Section 475. The 2025 Form 1099-DA includes guidance on tokenized securities and wash sale tracking.

  7. Stablecoins – Pegged to fiat currencies, taxed as property. The GENIUS Act enforces reserve and transparency rules without changing tax classification.

    Update October 6, 2025: While stablecoins are currently taxed like property (similar to other cryptocurrencies), the GENIUS Act introduces a potential—but not yet definitive—twist. The Act defines “payment stablecoins” issued by authorized entities, mandates 1:1 reserves, and exempts them from being classified as securities or commodities. Some tax commentary interprets this as allowing certain stablecoin payments to be exempt from gain or loss reporting, but that interpretation is not yet confirmed in IRS guidance or Treasury regulations. Until such guidance is issued, the default tax treatment still applies: selling or exchanging stablecoins is a taxable disposition, and spending them for goods or services generally triggers gain or loss just like other crypto transactions.

  8. Staking, Mining, Airdrops, Hard Forks – Staking earns rewards for validating proof-of-stake; mining earns coins for proof-of-work; airdrops distribute free tokens; hard forks create new coins. Ordinary income at FMV when received and when the taxpayer has dominion and control. Later sales produce capital gains and losses.

  9. Crypto Lending & Interest – Lending via DeFi or centralized platforms generates ordinary income when received; repayment in crypto may result in capital gains or losses if the value changes.

Summary Table

Type Example(s) Structure Tax Treatment Wash Sale Rules Section 1256 Eligible
Spot Cryptocurrency BTC, ETH Direct ownership Property – cap gains/losses No No
Bitcoin/Crypto Futures CME BTC, CME ETH Regulated futures on QBE 60/40, MTM, Form 6781 No Yes
Bitcoin Futures ETFs BITO RIC investing in CME futures Fund-level 60/40 / 1099-DIV Yes (security) Indirect only
Spot Bitcoin ETFs IBIT, FBTC Grantor trust Property – gains/losses No No
Tokenized Assets Tokenized stocks, bonds Depends on regulation Securities: wash sale; Property: capital gains/losses Varies Varies
CME Options CME BTC/ETH options Non-equity options on QBE 60/40, MTM, Form 6781 No Yes
Stablecoins USDC, USDT Pegged to Fiat Property – gains/losses No No

Compliance Highlights:

  • Broker Reporting (Form 1099-DA): IRS/Treasury finalized digital-asset broker rules in mid- and late-2024. Brokers must report gross proceeds for 2025 transactions on the 2026 Forms and the cost basis for 2026 transactions on the 2027 Forms. These rules apply to custodial platforms, specific hosted wallets, kiosks, and PDAPs; non-custodial broker rules will be addressed separately.

  • Section 6050I $10K Receipt Reporting: Implementation delayed.

  • Tax Return Question: Required on Forms 1040 and 1120-S. Whether they received (as a reward, award, or payment for property or services), or sold, exchanged, or otherwise disposed of a digital asset (or a financial interest in a digital asset). 

  • Worthless/Abandonment Losses: Must have a sale or abandonment for deduction.

Bottom Line: Digital asset trading encompasses spot crypto, futures, options on futures, ETF RICs, ETF grantor trusts, tokenized assets, stablecoins, and income-generating activities such as staking or lending. While most digital assets remain property for tax purposes, CME-traded futures and options on those futures qualify for Section 1256 benefits. Bitcoin futures ETFs structured as RICs are securities subject to wash sales, despite holding 1256 contracts internally, which allows investors to receive the 60/40 tax benefit indirectly. The new Form 1099-DA and potential legislation could significantly impact future tax compliance and reporting.

White House Update (July 30, 2025) – The Administration outlined priorities, including IRS guidance on wrapping/unwrapping transactions, de minimis exemptions, and streamlined broker consent for Form 1099-DAs. Congressional recommendations include treating digital assets as a new asset class, classifying payment stablecoins as debt, applying wash sale rules to most cryptocurrencies, and requiring the reporting of foreign digital asset accounts. Full report: whitehouse.gov/crypto.

**See our related post: **Crypto Still Taxed as Property Despite the GENIUS Act and CLARITY Bill

Crypto Still Taxed as Property Despite the GENIUS Act and CLARITY Bill

July 24, 2025 | By: Robert A. Green, CPA | Read it on

With the July 2025 enactment of the GENIUS Act and the House’s passage of the CLARITY Bill (pending in the Senate), the U.S. crypto regulatory framework is undergoing rapid evolution. Yet for traders and investors, one central question remains: Has the IRS changed how crypto is taxed?

Short answer: Not generally. The IRS continues to treat most cryptocurrencies and digital assets as “intangible property”—not as currency, securities, or commodities—unless specifically structured otherwise (e.g., Bitcoin futures are treated as Section 1256). Even if the SEC classifies a crypto asset as a security for regulatory purposes, the IRS does not automatically follow suit. (See the discussion of tokenized securities and commodities below, where there is some uncertainty.)

For tax purposes, the IRS maintains its stance, as outlined in Notice 2014-21 and subsequent updates: cryptocurrencies are treated as property unless they clearly fall into another tax category under specific provisions of the Internal Revenue Code. For a digital asset to be taxed as a security, it typically needs to resemble traditional equity instruments—such as corporate stock or bonds. Most cryptocurrencies do not meet these criteria. This divergence between regulatory and tax treatment is critical.

*See our related post: Digital Asset Trading Explained: Tax Rules for Crypto, ETFs, Futures, Options, and Tokens

Wash Sale Rules and Securities Treatment
If the IRS were to treat cryptocurrencies as securities, it would trigger wash sale loss (WSL) rules under Section 1091, which disallow a loss on a sale if the same or a substantially identical asset is repurchased within 30 days. WSLs are typically deferred to a replacement position in the same tax year; however, year-end WSLs can be deferred to the subsequent tax year, potentially increasing tax liability. WSLs are permanently lost if incurred in a taxable account and repurchased in an IRA. Tracking these losses would be burdensome for crypto traders and exchanges. Intangible property does not trigger WSLs.

Trader Tax Status and Section 475
Traders eligible for trader tax status (TTS) in securities may elect Section 475 mark-to-market (MTM) accounting, which converts capital gains and losses into ordinary income or loss. A 475 election avoids wash sale rules and the $3,000 capital loss limitation. Additionally, Section 475 income may qualify for the 20% qualified business income (QBI) deduction if income thresholds are met. However, Section 475 only applies to securities and commodities, not to property. A trader in cryptocurrencies can still benefit from TTS, which allows tax deductions for business expenses. Investors cannot deduct investment expenses.

New Form 1099-DA for 2025
The IRS will require brokers to issue Form 1099-DA for digital asset transactions starting in 2025, with gross proceeds reporting in 2025 and cost basis reporting in 2026. This new form adds enforcement pressure—but does not change the IRS’s treatment of crypto as property.

Key Tax Takeaways for Crypto Traders

  • Crypto remains taxed as property under capital gains rules.

  • Crypto is not subject to wash sale rules under Section 1091.

  • Section 475 MTM and the QBI deduction do not apply to crypto.

  • Long-term holders benefit from tax deferral and reduced rates.

What to Watch For

  • The IRS maintains that crypto is property, regardless of SEC or CFTC classification.

  • GENIUS Act enhances reporting for stablecoin issuers—no tax effect.

  • The CLARITY Bill (pending Senate review) would regulate based on decentralization—still no tax impact.

  • Congress previously considered, but did not pass, applying WSL rules to crypto.

Commodity Futures and Digital Asset Contracts
Traders often use Bitcoin futures and select digital asset contracts that qualify as regulated futures contracts (RFCs). For example, Bitcoin futures traded on CME Group are taxed under Section 1256.

To qualify as a commodity futures contract for tax purposes, a digital asset must:

  • Be a regulated futures contract (RFC)

  • Trade on a qualified board or exchange (QBE)

  • Be under CFTC oversight

Structure and oversight—not just tracking a commodity—determine tax treatment. Tokenized commodities like digital grain contracts generally trade on non-regulated platforms and are taxed as property.

Section 1256 tax benefits:

  • 60% long-term / 40% short-term capital gains split

  • Annual mark-to-market on Form 6781

  • Exemption from wash sale rules

Compared to spot crypto, Section 1256 contracts offer lower effective tax rates and simpler year-end reporting.

Bitcoin ETFs: Taxed as Property, Not Securities
Spot Bitcoin ETFs, such as iShares Bitcoin Trust (Ticker: IBIT, NASDAQ) and Fidelity Wise Origin Bitcoin Fund (Ticker: FBTC, CBOE BZX Exchange), are structured as grantor trusts. Investors are treated as direct owners of the underlying Bitcoin.

Tax treatment:

  • Treated as property (like direct Bitcoin holdings)

  • Subject to capital gains/losses upon sale

  • Not subject to wash sale rules

  • Not eligible for Section 475 or QBI deduction

This reinforces the broader IRS position: digital assets remain property for tax purposes.

IRS Form 1099-DA and Tokenized Securities
Beginning January 1, 2025, brokers—including exchanges and hosted wallet providers—must issue Form 1099‑DA: Digital Asset Proceeds From Broker Transactions. Finalized in early 2025, the form includes gross proceeds in 2025 and cost basis reporting in 2026.

Box 1i addresses wash sale loss disallowed, although WSL rules currently do not apply to most crypto. If the asset is a tokenized security that meets the definition of a “security” under Section 1091, then wash sale losses may be disallowed.

The IRS instructions clarify that tokenized securities—digital assets registered with the SEC and representing traditional stocks, bonds, or fund shares—must be reported on Form 1099-DA (not 1099-B) with a CUSIP. Examples include security tokens under Regulation D, tokenized equities like INX, and blockchain-based REIT or bond tokens. Most cryptocurrencies and stablecoins remain exempt.

GENIUS Act: Stablecoin Oversight, Not a Tax Shift
The GENIUS Act mandates 1:1 reserve backing, monthly disclosures, executive certifications, and GAAP audits for stablecoin issuers exceeding $50 billion in market cap.

Tax impact: None. The IRS continues to treat all crypto—including stablecoins—as property.

Update October 6, 2025: Some interpretations of the GENIUS Act suggest that certain “qualified payment stablecoin” transactions may be exempt from gain or loss reporting when used for everyday purchases. However, until the IRS and Treasury issue formal guidance, stablecoins remain taxable property under current rules—meaning gains or losses are recognized upon sale, exchange, or use in payment for goods or services.

CLARITY Bill: Regulatory Designations, Not Tax Reclassifications (Pending Senate Review)
The CLARITY Bill, passed by the House, is pending Senate review. It assigns oversight based on functionality and decentralization.

Asset Type Regulatory Status Overseen By
Centralized tokens / ICOs Security SEC
Decentralized tokens Commodity CFTC
Transitional assets Evolving SEC or CFTC

Tax impact: No immediate change. The IRS’s property classification remains.

Bottom Line
Crypto remains intangible property for tax purposes, even under new and pending legislation. This means:

  • No wash sale rules

  • No Section 475 mark-to-market election

  • No QBI deduction

Disclaimer: This post is for informational purposes only and does not constitute legal or tax advice. Consult a qualified tax professional for guidance tailored to your situation.

Contributors: Darren Neuschwander, CPA, and Adam Manning, CPA

Sources:

  • IRS Notice 2014-21 and subsequent IRS crypto guidance

  • GENIUS Act (S.1582), signed into law July 18, 2025

  • CLARITY Bill (H.R.3633), passed House July 17, 2025 (pending Senate review)

  • IRS 2025 Form 1099-DA Instructions

  • Checkpoint News, Consumer Reports, Financial Times, and agency press releases

Update Policy Outlook: White House Report Signals Potential Crypto Tax Shifts

As reported by Thomson Reuters/PPC on August 4, the White House released a report outlining its top priorities for digital asset taxation. While no new laws or IRS guidance have been finalized, the report signals the direction of future crypto tax policy. Key recommendations include: 

  • IRS/Treasury Guidance Priorities:

    • Clarify whether wrapping/unwrapping digital assets (e.g., wrapping ETH into WETH) are taxable events.

    • Update the IRS’s Frequently Asked Questions on digital assets.

    • Provide administrative relief for de minimis digital asset receipts, possibly exempting small crypto rewards or payments from tax reporting.

    • Ease broker compliance by proposing simplified electronic consent procedures for furnishing Form 1099-DA payee statements.

  • Legislative Recommendations to Congress:

    • Create a new tax classification for digital assets, with modified rules derived from existing securities and commodities tax law.

    • Treat payment stablecoins as debt instruments, which could shift their tax treatment significantly.

    • Apply wash sale rules to digital assets (excluding payment stablecoins), ending a major tax benefit for crypto traders.

    • Require taxpayers to report foreign digital asset accounts, similar to FBAR rules for bank accounts.

While these proposals are not yet law, they reflect a growing push to integrate digital assets more deeply into the formal tax code. If enacted, they could significantly alter how traders and investors manage crypto tax planning.

👉 Full report available at: whitehouse.gov/crypto

 

Watch Out Cryptocurrency Owners, The IRS Is On The Hunt

July 31, 2019 | By: Robert A. Green, CPA | Read it on

The massive tax bust of crypto owners has begun with the IRS mailing 10,000 letters to crypto account owners. These letters educate crypto account holders about the rules and tell taxpayers to review their tax reporting for crypto transactions to be sure they reported income correctly. If necessary, taxpayers should file amended tax returns and or late returns. These tax returns should be marked with the corresponding letter type (i.e., Letter 6173, 6174 or 6174-A) and mailed to a particular IRS address. In other words, these tax filings won’t be a needle in the haystack and the IRS will take a close look. Many audits may follow.

IRS Letter 6173

“We have information that you have or had one or more accounts containing virtual currency and may not have met your U.S. tax filing and reporting requirements for transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.”

The IRS might know there is unreported income based on tax information obtained through enforcement actions, which include the summons against U.S. Coinbase customers. You received the letter because you didn’t file a tax return, which should have included virtual currency transactions. Alternatively, you filed a return but did not report virtual currency transactions. You must reply to this tax notice by submitting a correct late tax return or an amended return. If you disagree with the IRS, the letter requires a full explanation with a signed statement declared under penalties of perjury.

Letter 6173 is a severe tax notice, and you should not dig yourself into a bigger hole with an incorrect reply. In some cases, perjury could be a felony. The letter states, “If we don’t hear from you by the “respond by” date we may refer your tax account for examination.”

I wonder how the IRS will conduct its audits of virtual currency transactions. They will need a list of all coin exchanges and private wallets and probably have to use trade accounting software in the same way a taxpayer would.

IRS Letter 6174

“We have information that you have or had one or more accounts containing virtual currency but may not know the requirements for reporting transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies. After reviewing the (educational) information below, if you believe you didn’t accurately report your virtual currency transactions on a federal income tax return, you should file amended returns or delinquent returns if you didn’t file a return for one or more taxable years.”

The key phrase is that the taxpayer “may not know” crypto tax treatment. It sounds like the IRS does not have sufficient information indicating unreported income. Letter 6174 is an “educational letter,” and it states, “you do not need to respond to this letter.” If you received this tax notice, then you should review your crypto tax reporting and consider filing an amended tax return, if appropriate. Consider the IRS advice a warning shot across your bow.

Letter 6174-A

“We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies. After reviewing the information below, if you believe you didn’t accurately report your virtual currency transactions on a federal income tax return, you should file amended returns or delinquent returns if you didn’t file a return for one or more taxable years. You do not need to respond to this letter.”

The critical phrase is “may not have properly reported.” That’s different from Letter 6173, which states “may not have met” your tax requirements. Letter 6174-A implies the taxpayer reported crypto transactions, but perhaps not in the proper way. For example, maybe the taxpayer used Schedule C (business income) instead of Form 8949 (capital gains). Perhaps they used like-kind exchanges, and the IRS might not allow that. Conversely, Letter 6173 indicates the taxpayer did not report crypto transactions at all.

The IRS has various types of tax information for virtual currency account owners, and it selected the letter that best matched their knowledge base. The IRS is also using third-party services to obtain more tax information. It’s wise to come clean now if you know you have errors in reporting crypto transactions. Historically, taxpayers have performed better in seeking abatement of penalties if they come forward to the IRS before getting busted first.

Civil and criminal prosecution and FBAR reporting
The IRS stressed, “Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties, and interest. In some cases, taxpayers could be subject to criminal prosecution.” The IRS sent mob boss Al Capone to prison for tax evasion, which was less challenging than indicting him for unlawful bootlegging. Learn about accuracy-related penalties and what constitutes reasonable cause for reduction of penalties.

The IRS Virtual Currency Compliance campaign reminds me of IRS initiatives to hunt down hidden offshore bank and brokerage accounts. FATCA legislation forced foreign banks into reporting on U.S. resident accounts. The IRS Offshore Voluntary Disclosure Program (OVDP) helped taxpayers come clean with voluntary reporting. That led to reduced penalties, which otherwise were onerous. Some tax cheats used foreign bank accounts to conceal business income from the IRS. Others protected assets with offshore structures and only did not correctly report portfolio income.

In retrospect, it seems the IRS made a mistake in (unofficially) waiving foreign bank account report FinCEN 114 and Form 8938 for offshore virtual currency accounts. Virtual currency is “property,” which did not meet the requirements for FinCEN 114 and Form 8938 (Statement of Specified Foreign Financial Assets). There are significant penalties for not filing FinCEN 114 (previously known as FBAR) on time with the U.S. Treasury. Once you put Treasury on notice of owning these accounts, it dissuades you from hiding income from the IRS on those same accounts.

Coin-to-coin exchanges
In the educational section of these IRS letters, it states that crypto-to-crypto trades (i.e., Bitcoin for Ether) are taxable capital gains. The letter does not mention Section 1031 or like-kind exchanges being allowed on pre-2018 trades. (The new tax law TCJA restricted like-kind exchanges to real property only, starting in 2018.) Many crypto traders did not report deferred capital gains on coin-to-coin trades. Some may have, but they omitted the required Form 8824.

I’ve questioned whether coin-to-coin trades qualify for like-kind exchange treatment in years before 2018. Different types of virtual currencies might not be eligible as like-kind property, and coin exchanges are not qualified intermediaries. Multi-party like-kind exchanges require both.

Tax information statements and trade accounting
The IRS letters say to report all transactions whether tax information statements (Form 1099) were sent, or not, for crypto accounts held in the U.S., or abroad. Cryptocurrencies are “property,” not a “security,” so it’s not a “covered security” for purposes of 1099-B reporting. Coinbase, the largest U.S. crypto exchange, appeased the IRS during their fight for obtaining taxpayer information, by issuing a Form 1099-K for larger accounts. The IRS intended Form 1099-K for third-party network transactions for merchants; not traders or investors. Only U.S. exchanges might provide 1099-Ks. Coinbase also provided capital gain and loss reports for later years.

Taxpayers should consider using a trade accounting solution or software program to download virtual currency transactions from all coin exchanges and private wallets. Many crypto owners have accounts around the world, and accounting issues are more challenging when trading on margin. The IRS will likely use this same software in an exam.

Additional IRS guidance coming soon
The IRS keeps promising to publish further advice on crypto tax treatment soon. Why did they send 10,000 education letters if they plan to update their education guidance shortly? Perhaps, it would have been better to publish updated guidance before mailing them. This letter campaign seems a bit like a fishing expedition: The IRS wants more tax returns to analyze before it tackles tax treatment issues further.

Additional guidance is expected to address like-kind exchanges; chain splits, permissible accounting methods, wash sales, Section 475, and more. The AICPA issued a letter containing suggested questions and answers. The basics are clear, and the delay in additional guidance is no excuse for non-compliance.

IRS data analytics
The IRS said it would continue to use data analytics, and perhaps other blockchain technology to uncover more non-compliant crypto taxpayers. The IRS successfully used an independent company Chainalysis on recovering tax information from U.S. Coinbase customers. That may have been one of the sources for this first batch of 10,000 account letters.

What tax evaders didn’t initially realize is that virtual currencies may not be an ideal medium of exchange for concealing income and assets from tax authorities. Unlike using cash (dollar bills), blockchain is a distributed ledger which is available to the public. Non-crypto virtual currency may have a private company centralized ledger, but the IRS might be able to get that through a summons, too. AI, blockchain tools, and crypto trade accounting programs will help the IRS bust crypto tax evaders and taxpayers who are honest but misinformed.

Takeaway
This IRS letter campaign is just the beginning of virtual currency enforcement activities to come. You should take this opportunity to get fully educated, review your reporting, and be sure you are tax compliant. Pay tax liabilities and interest expenses, and then seek abatement of penalties when assessed. Some crypto users might try to claim ignorance or argue they received terrible tax advice. Others might assert that the crypto tax rules were too vague and uncertain at the time of filing. Some tax treatment issues are unknown (i.e., like-kind exchanges and hard forks), but the basics are clear. After receiving these education letters, which are warning shots, there are no grounds for continued non-compliance.

Consult a crypto tax expert immediately after receiving any of the above IRS letters. The CPA can reply to Letter 6173 soon and request more time to file amended returns. The 2018 tax return deadlines are coming up on September 15, 2019, for entities, and October 15 for individuals. Plan to work with your CPA after those dates on amended tax return filings.

Breaking news and more resources

IRS IR-2019-132: IRS has begun sending letters to virtual currency owners advising them to pay back taxes, file amended returns; part of agency’s larger efforts. 

WSJ quotes my partner in IRS Sending Warning Letters to More Than 10,000 Cryptocurrency Holders. “When it comes to preparing tax returns involving cryptocurrencies, Darren Neuschwander, a certified public accountant, said many tax preparers are frustrated because the IRS has long promised new guidance on cryptocurrencies that it hasn’t yet released.” “It’s ironic that the IRS is issuing these letters because we’re still waiting to know more rules,” he said.

IRS Sends Out 10,000 Letters to Virtual Currency Investors, Some of Which Demand a Response, By Ed Zollars CPA for Kaplan Financial Education.

Blockchain Analytics Firm Chainalysis Outlines User Data Policy Amid Coinbase Allegations in CoinTelegraph.

The IRS Has Special Software to Find Bitcoin Tax Cheats. Fortune.com

GreenTraderTax cryptocurrency resources:
Tax Center
Blog posts on cryptocurrencies
Green’s 2019 Trader Tax Guide
Trade accounting service for cryptocurrencies

Darren Neuschwander CPA contributed to this blog post.

 

Hope For Active Crypto Traders With Massive Losses

June 16, 2018 | By: Robert A. Green, CPA | Read it on

The AICPA recently asked the IRS to permit cryptocurrency traders, eligible for trader tax status (TTS), to use a Section 475 MTM election on securities and commodities providing for ordinary gain or loss treatment.

In my March 2018 blog post Cryptocurrencies: Trader Tax Status Benefits And Section 475 Issues, I suggested crypto TTS traders consider filing a protective 2018 Section 475 election on securities and commodities, due by April 17, 2018, in case the IRS allowed it. Many crypto traders had significant losses in early 2018 with the market correction, and with a 475 election, they might avoid the $3,000 capital loss limitation using ordinary loss treatment. I said it hinged on whether the IRS changed its designation of crypto from intangible property to a security or a commodity.

The AICPA letter* implied that the IRS could keep its current classification of crypto as intangible property, yet still permit the use of Section 475.  However, it does raise other questions: The AICPA letter did not distinguish between securities and commodities, whereas, Section 475 does. TTS traders may elect Section 475 on securities only, commodities only, or both, and that has other tax implications.

If the IRS considers crypto a security, then Section 1091 wash-sale loss rules for securities would apply. Wash-sale loss adjustments are a headache and can be costly. (If you buy back a losing trade 30 days before or after, you must defer the wash-sale loss to the replacement position’s cost basis.) As intangible property, crypto is not currently subject to wash-sale losses. A Section 475 election on securities exempts TTS traders from making wash-sale loss adjustments.

If the IRS considers crypto a commodity, then a TTS trader should be able to elect Section 475 on commodities. However, that election has other tax consequences: If you trade Section 1256 contracts, including futures, you will surrender the lower 60/40 capital gains rates on 1256 contracts. For that reason, most traders elect Section 475 on securities only.

AICPA letter excerpt
8. Traders and Dealers of Virtual Currency

“Overview: Taxpayers considered dealers and traders who engage in buying and selling securities in the ordinary course of business to customers may make a ‘mark-to-market’ election under section 475. This election recognizes ordinary gains or losses on the deemed sales involved in the mark-to-market process. The securities holdings on the last day of the year are deemed as sold for their fair market value resulting in both ordinary income and ordinary expenses the same as for any other trade or business. Taxpayers who trade virtual currencies perform this activity on virtual currency exchanges that contain all the robust trading features available on trading platforms for securities and commodities, including the same level of liquidity. In this context, virtual currencies are akin to securities and commodities. This particular issue is also under consideration by the Commodity Futures Trading Commission.

Suggested FAQ
Q-22: May taxpayers who trade virtual currency elect the mark-to-market rules under section 475 if they otherwise qualify as a dealer or trader?

A-22: Yes. The nature of virtual currency trading is akin to dealers and traders of securities and commodities and a taxpayer may elect mark-to-market treatment. The taxpayer must otherwise qualify as a dealer or trader in order to make the election.

* The IRS has made no indication that they intend to adopt all, or any, of the many excellent recommendations from the AICPA.

SEC update
On June 14, CNBC reported, “The SEC’s point man on cryptocurrencies and initial coin offerings (ICOs) says that bitcoin and ether are not securities but that many, but not all, ICOs are securities and will come under the regulatory control of the SEC and relevant securities laws.”

The official explained what constitutes a security in the eyes of the SEC. An initial coin offering is likely a security because a third-party company, which is not decentralized ownership, sells an investment product to the public. The sponsor uses the money raised for its internal use. The buyer/investor expects a profit — a return on the investment. Conversely, bitcoin and ether are likely not securities because there was no ICO, ownership is decentralized, and they were not sold as investments.

Spending Crypto For Personal Use Can Be A Tax Mistake

June 4, 2018 | By: Robert A. Green, CPA | Read it on

If a taxpayer purchases virtual currency (cryptocurrency) and spends it on personal use, the IRS requires him to calculate a capital gain or loss on each transaction. Capital gains on personal-use property are reportable and subject to tax, whereas, the IRS disallows capital losses.

The AICPA recently asked the IRS for some equitable relief by adopting a “de minimus election,” which provides a $200 threshold for excluding capital gains income on personal transactions. (See the AICPA letter and an excerpt of the de minimus rule proposal below.)

If a taxpayer acquires virtual currency as an investment, though, then all capital gains and capital losses are reportable, and the de minims rule should not apply.

The AICPA suggests the IRS apply a similar de minimus rule used for foreign currency transactions in Section 988(e)(2) (see below). The code section refers to personal purchases, not Section 162 business or Section 212 investment property. For example, if a taxpayer acquired Euros for a European vacation, the de minimus rule applies, and the taxpayer can exclude capital gains on the Euros spent if the capital gain is under $200 per transaction.

The IRS does not permit taxpayers to deduct capital losses on personal-use property, including foreign currency or virtual currency held for personal use. Taxpayers may not deduct capital losses on the sale of a private auto or a primary residence.

Examples of using crypto for personal use vs. investment property

1.    Joe purchased one Bitcoin in early 2017 for personal-use spending, and his Bitcoin rose in price substantially during the year. Joe planned on many vendors adopting Bitcoin as a means of payment. Joe’s original intention was for personal use, so a de minimus exemption should apply to him if the IRS approves that AICPA recommendation*. If Joe bought Bitcoin in 2018, he might have a capital loss, which would be non-deductible on personal-use property.

2.    Nancy invested in 10 Bitcoins in early 2017, and her intention was capital appreciation and diversification into a new asset class. She spent Bitcoin frequently during the year on personal transactions, buying goods and services wherever Bitcoin was accepted. She hoped it would be tax-free, but it’s not.

The intention of the taxpayer is critical in determining tax treatment. If the aim is for personal use, then the de minimus rule should apply to capital gains under $200, and capital losses are not deductible. If the intention is for investment, then it’s capital gains and losses. If the purpose is for business, ordinary gain or loss treatment applies.

With tax treatment hinging on category (personal use, investment, and business), it’s wise to segregate cryptocurrency into these buckets carefully. If the IRS agrees with the AICPA proposal on the de minimus exemption, declare a crypto wallet for personal use, and the rest as an investment to protect capital loss treatment on the bulk of your crypto that you don’t plan to spend.

Excerpt from the AICPA letter
4. Need for a De Minimis Election

“Overview: Some taxpayers may only have a minimal amount of virtual currency that is designated for making small purchases (such as buying coffee). Tracking the basis and FMV of the virtual currency for each of these small purchases is time consuming, burdensome, and will yield a de minimis amount of gain or loss. A binding election applicable for a specified amount of virtual currency is beneficial to taxpayers.

Currently, section 988(e)(2) allows for an exclusion of up to $200 per transaction for foreign currency exchange rate gain, if derived from personal purchase. The same exclusion should apply to virtual currencies even though they are considered property rather than foreign currency.

Suggested FAQ

Q-9: May individuals use a de minimis rule for virtual currency similar to the section 988(e)(2) exclusion of up to $200 per transaction for foreign currency exchange rate gain?

A-9: Yes. Individuals may use a de minimis rule, similar to section the 988(e)(2) exclusion, for virtual currency transactions to alleviate the burden or recordkeeping for individuals who use virtual currency as a medium of exchange. This de minimis rule allows taxpayers to exclude transactions resulting in $200 or less of gain.”

Section 988(e)(2) Exclusion for certain personal transactions
“If—

(A) nonfunctional currency is disposed of by an individual in any transaction, and

(B) such transaction is a personal transaction,

no gain shall be recognized for purposes of this subtitle by reason of changes in exchange rates after such currency was acquired by such individual and before such disposition. The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200.

(3) Personal transactions. For purposes of this subsection, the term “personal transaction” means any transaction entered into by an individual, except that such term shall not include any transaction to the extent that expenses properly allocable to such transaction meet the requirements of—

(A) section 162 (other than traveling expenses described in subsection (a)(2) thereof), or

(B) section 212 (other than that part of section 212 dealing with expenses incurred in connection with taxes).”

(Note: Section 162 is for business, and Section 212 is for investments.)

* The IRS has made no indication that they intend to adopt all, or any, of the many excellent recommendations from the AICPA. 

Accounting Method Impacts Crypto Income Taxes

April 10, 2018 | By: Robert A. Green, CPA | Read it on

Many crypto traders face massive tax bills for 2017. Which accounting method they apply could change their tax bills by tens of thousands of dollars.

Specific identification vs. FIFO
The IRS wants the “specific identification” (SI) accounting method used on property transactions, which applies to crypto. SI requires “adequate identification” of units sold, but most crypto traders cannot comply with these formal IRS regulations.

Many crypto traders and accountants use the alternative “first in first out” (FIFO) accounting method. FIFO is reliable and practical. A side benefit of FIFO is longer holding periods with potential qualification for long-term capital gains tax at 0%, 15%, and 20% graduated rates.

But FIFO likely raised tax bills for many crypto traders in 2017, because coin prices rose dramatically during the year. Selling coins purchased at lower prices (cost basis), increased 2017 capital gains. Many traders held significant amounts of crypto at year-end, embedded with higher cost-basis. If these traders complied with SI adequate identification rules, they might have reduced capital gains income by choosing higher-cost lots for sale.

Special IRS rule for securities
Thomson Reuters tax publishers explains the FIFO rule as follows:

“Except for stock for which the average basis method is available (i.e., mutual fund shares), if a taxpayer sells or transfers corporate stock that the taxpayer purchased or acquired on different dates or at different prices, and the taxpayer doesn’t adequately identify the lot from which the stock is sold or transferred, the stock sold or transferred is charged against the earliest lot purchased or acquired to determine the basis and holding period of the stock.

“An adequate identification is made if the taxpayer, ‘at the time of the sale or transfer,’ specifies what particular shares are to be sold or transferred and, within a reasonable time after that, the broker or other agent confirms the specification in a written document. In this event, the taxpayer’s instruction prevails even though delivery was actually made from a different lot. Stock identified under this rule is considered to be the stock sold or transferred by the taxpayer, even if stock certificates from a different lot are actually delivered to the taxpayer’s transferee. For this purpose, an adequate identification of stock is made at the time of sale, transfer, delivery or distribution if the identification is made no later than the earlier of the settlement date or the time for settlement required by Rule 15c6-1 under the Securities Exchange Act of 1934. A standing order or instruction for the specific identification of stock is treated as an adequate identification made at the time of sale, transfer, delivery or distribution.”

The tax court and IRS relaxed SI rules in some cases, but more stringent IRS regulations remain the law. In Concord Instruments Corp, (1994) TC Memo 1994-248, per Thomson Reuters,

“Taxpayer had maintained cost records of each lot of stock that was purchased, the date of purchase, and the price per share. T’s accountant used these records to prepare T’s income tax returns. To compute the gain from T’s stock sales, the specific identification method was used and the highest cost shares were treated as sold first. The court concluded that Taxpayer had sufficiently identified the stock sold to avoid the FIFO method of reporting the gains.”

The tax court allowed oral communication by the trader to the broker and the court relaxed the broker rules for providing contemporaneously written confirmation.

With high-speed trading on coin exchanges, it seems nearly impossible to comply with adequate identification rules for the SI accounting method. Crypto traders don’t use brokers; they trade online over coin exchanges without any communication between trader and exchange. Would the IRS consider this situation to be compliant with SI adequate identification rules? Maybe not.

New York tax attorney Roger D. Lorence says: “Given how longstanding this regulation is, I would describe it as having in effect the force of law.  The legal effect is to create a rebuttable presumption of its correctness; the presumption is overcome only upon the showing of strong proof.  Unless the cryptocurrency trader has contemporaneous records showing specific identification, if they are in the US Tax Court, they would be held to FIFO.”

AICPA weighs in
In June 2016, the AICPA asked the IRS if crypto traders could use FIFO as an alternative accounting method. (See Comments on Notice 2014-21: Virtual Currency Guidance.)

“Allow an alternative treatment under section 1012 (e.g., first in first out (FIFO)). The treatment of convertible virtual currency as noncash property means that any time virtual currency is used to acquire goods or services, a barter transaction takes place, and the parties need to know the fair market value (FMV) of the currency on that day. The party exchanging the virtual currency for the goods or services will need to also track the basis of all of his or her currency to determine if a gain or loss has occurred and whether it is a short-term or long-term transaction. This determination involves a significant amount of recordkeeping, even if the transaction is valued at under $10.

“Currently, there are no alternative tracking methods provided for such transactions (other than for securities under Treas. Reg. § 1.1012-1(c)). Therefore, taxpayers are required to specifically identify which virtual currency lot was used for each transaction in order to properly determine the gain or loss for that particular transaction. In many cases, it is impossible for a taxpayer to track which specific virtual currency was used for a particular transaction.”

Example of specific identification
A crypto trader bought 20 Bitcoins before 2017 at low prices. He bought 30 more Bitcoins between January and June 2017 at materially higher rates. In July 2017, he transferred the 30 Bitcoins purchased in 2017 to a coin exchange. He kept the original 20 in his wallet off-exchange. He adequately identified the 30 newer units for the trading. He used and complied with SI, and it saved him thousands of dollars in capital gains taxes compared to using FIFO.

Cherry picking
Choosing an option in a trade accounting program to cherry pick the highest cost basis for lowering capital gains after the fact is likely not acceptable to the IRS. “Last in first out” (LIFO) is also expected not acceptable.

File an extension
I suggest crypto traders file extensions for 2017 by April 17, 2018, to avoid late-filing penalties of 5% per month (up to a maximum of 25%). Hopefully, the IRS will issue new guidance addressing permissible accounting methods and their application in the real world of crypto trading.

Consult with a cryptocurrency trade accounting expert.

Darren Neuschwander CPA contributed to this blog post.

 

Cryptocurrencies: Trader Tax Status Benefits And Section 475 Issues

March 14, 2018 | By: Robert A. Green, CPA | Read it on

Active cryptocurrency (coin) traders can qualify for trader tax status (TTS) to deduct trading business expenses and home-office deductions. TTS is essential in 2018: The Tax Cuts and Jobs Act suspended investment expenses, and the IRS does not permit employee benefit plan deductions on investment income. A TTS trader can write off health insurance premiums and retirement plan contributions by trading in an S-Corp with officer compensation.

The benefits of Section 475
There’s an additional critical tax benefit with TTS: Electing Section 475 mark-to-market accounting (MTM) on securities and/or commodities. Section 475 turns capital gains and losses into ordinary gains and losses thereby avoiding the $3,000 capital-loss limitation and wash-sale loss adjustments on securities (this is what I like to call “tax-loss insurance”). Many coin traders incurred substantial trading losses in Q1 2018, and they would prefer ordinary loss treatment to offset wage and other income. Unfortunately, most coin traders will be stuck with significant capital-loss carryforwards and higher tax liabilities.

There are benefits to 475 income, too. The new tax law ushered in a 20% pass-through deduction on qualified business income (Section 199A), which likely includes Section 475 ordinary income, but excludes capital gains. Trading is a specified service activity, requiring the owner to have taxable income under a threshold of $315,000 (married) or $157,500 (other taxpayers). There is a phase-out range above the limit of $100,000 (married) and $50,000 (other taxpayers).

The IRS says cryptocurrency is intangible property
In March 2014, the IRS issued long-awaited guidance declaring coin “intangible property,” before regulators thoroughly assessed coin. Section 475 is for securities and commodities and does not mention intangible property. An AICPA task force on virtual currency asked the IRS for further guidance (AICPA letter), including if coin traders could use Section 475. The IRS has not yet replied. When an investor holds cryptocurrencies as a capital asset, they should report short-term vs. long-term capital gains and losses on Form 8949. (See Cryptocurrency Traders Owe Massive Taxes For 2017.)

SEC and CFTC weigh in
The U.S. Securities and Exchange Commission (SEC) recently stated Initial Coin Offerings (ICOs) might be securities offerings, which most likely need to register with the SEC. It further said coins or tokens might be securities, even if the ICO calls them something else. According to an SEC statement, “If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.” (See SEC ICO information.)

The U.S. Commodity Futures Trading Commission (CFTC) defined cryptocurrencies as commodities in 2015. During a March 7, 2018, CNBC interview, Commissioner Brian Quintenz said the CFTC has enforcement authority, but not oversight authority, over cryptocurrencies traded in the spot market on coin exchanges. The CFTC has enforcement and oversight authority for derivatives traded on commodities exchanges, like Bitcoin futures.

Also on March 7, 2018, a U.S. district judge in New York ruled in favor of the CFTC, stating “virtual currencies can be regulated by CFTC as a commodity.” (See Cryptos Are Commodities, Rules US Judge In CFTC Case.)

Will the IRS change its mind?
There is a long-shot possibility the IRS could change its tune to treat cryptocurrency as a security and or a commodity as a result of recent actions from the SEC and CFTC, including the statements mentioned above. Then coin might fit into the definition of securities and/or commodities in Section 475. Until and unless the IRS updates its guidance, coin is intangible property, which is not listed in Section 475.

If you incurred substantial trading losses in cryptocurrencies in Q1 2018, and you qualify for TTS, you might want to consider making a protective 2018 Section 475 election on securities and commodities by April 17, 2018 (or by March 15 for partnerships and S-Corps). The IRS has a significant workload drafting regulations for the new tax law, and with limited resources, I don’t expect it to update coin guidance shortly.

There is a side effect of making a 475 election on commodities: If you also trade Section 1256 contracts, you surrender the lower 60/40 capital gains rates. Perhaps, you only trade coin and don’t care about Section 1256 contracts. If coin is deemed a commodity for tax purposes, it’s still likely not a Section 1256 contract unless it lists on a CFTC-registered qualified board or exchange (QBE). Coin exchanges or marketplaces are currently not QBE.

Section 475 provides for the proper segregation of investment positions on a contemporaneous basis, which means when you buy the position. If you have a substantial loss in coin that you’ve held onto for months before the sale, the IRS will likely consider it a capital loss on an investment position.

Bitcoin futures
Bitcoin futures trade on the CME and CBOE exchanges. The product appears to be a regulated futures contract (RFC) trading on a U.S. commodities exchange, meeting the tax definition of a Section 1256 contract. That means it also fits the description of a commodity in Section 475.

Section 1256 contracts have lower 60/40 capital gains tax rates, meaning 60% (including day trades) are taxed at the lower long-term capital gains rate, and 40% are taxed at the short-term rate, which is the ordinary tax rate. Section 1256 is mark-to-market accounting, reporting unrealized gains and losses at year-end.

TTS traders usually elect 475 on securities only to retain these lower rates on Section 1256 contracts. A Section 1256 loss carryback election applies the loss against Section 1256 gains in the three prior tax years, and unused amounts are carried forward.

If a TTS trader has a substantial loss in Bitcoin futures, he or she should consider making a 2018 Section 475 election on commodities for ordinary loss treatment. (See Consider 475 Election By Tax Deadline To Save Thousands.)

Cryptocurrency investment trusts
According to Grayscale’s website, the company is “the sponsor of Bitcoin Investment Trust, Bitcoin Cash Investment Trust, Ethereum Investment Trust, Ethereum Classic Investment Trust, Litecoin Investment Trust, XRP Investment Trust and Zcash Investment Trust. The trusts are private investment vehicles, are NOT registered with the Securities and Exchange Commission.” The Grayscale cryptocurrency investment trusts list on OTC markets.

According to its prospectus, Bitcoin Investment Trust is a Grantor Trust, a publicly traded trust (PTT). “Treatment of an interest in a grantor trust holding crypto assets means that you have to look through the trust envelope to the underlying positions,” says New York tax attorney Roger Lorence JD.

It’s similar to other PTTs; like the SPDR Gold Shares (NYSEArca: GLD) with long-term capital gains using the collectibles tax rate applicable to precious metals. With the look-through rule, the cryptocurrency investment trusts are subject to taxation as intangible property.

Excess business losses
The new tax law limits current year business losses to $500,000 (married) and $250,000 (other taxpayers) starting in 2018. The excess business loss carries forward as a net operating loss (NOL). In 2017, there wasn’t a limit, and taxpayers could carryback NOLs two tax years and/or forward 20 years. Section 475 losses often generated immediate tax refunds from NOL carryback returns. At least NOL carryforwards are better than capital loss carryovers.

Several coin traders face a tax trap
They had massive capital gains in 2017 and had not yet paid the IRS and state their 2017 taxes owed. Meanwhile, in Q1 2018, their coin portfolios significantly declined in value, and they incurred substantial trading losses. They now face a significant tax problem: They need to sell cryptocurrencies to raise cash to pay their 2017 tax liabilities due by April 17, 2018. That would leave many of them with little coin left to continue trading. They may choose to file their automatic extensions without tax payment or a small payment and incur a late-payment penalty of 0.5% per month by the extension due date of Oct. 15, 2018. They are banking on coin prices increasing and thereby generating trading gains by Oct. 15. It reminds me of trading on margin; only the bank (in this case, tax authorities) cannot force a sale now. (See Tax Extensions: 12 Tips To Save You Money.)

A Section 475 election is not a savior in this situation: Section 475 turns 2018 capital losses into ordinary losses on TTS positions, but the IRS no longer allows NOL carryback refunds. In prior years, a trader with this problem could hold the IRS at bay, promising to file an NOL carryback refund claim to offset taxes owed for 2017.

Mining inventory vs. capital assets
When a miner receives coin, it’s revenue. The net income after mining expenses is ordinary income and self-employment income. If the miner converts that coin from mining inventory to a capital asset, subsequent sales or exchanges of that coin are capital gains and losses, not ordinary income or loss. Most coin accounting programs assume a conversion to capital asset treatment takes place. However, a miner may not intend to convert coin to a capital asset, and instead leave the coin in inventory. A subsequent sale or exchange would then be an ordinary gain or loss as part of the mining business.

How to qualify for trader tax status
Are you unsure if you are eligible for TTS? Here are the GreenTraderTax golden rules for qualification based on an analysis of trader tax court cases and years of tax compliance experience.

– Volume: three to four trades per day. Don’t count when the coin exchange breaks down an order into multiple executions.
– Frequency: trade executions on 75% of available trading days. If you trade five days per week, you should have trade orders executed on close to four days per week.
– Holding period: The Endicott court required an average holding period of fewer than 31 days.
– Hours: at least four hours per day, including on research and administration.
– Taxable account size: material to net worth, and at least $15,000 during the year.
-Intention to make a primary or supplemental living. You can have another job or business, too.
– Operations: one or more trading computers with multiple monitors and a dedicated home office.
– Automation: You can count the volume and frequency of a self-created automated trading system, algorithms or bots. If you license the automation from another party, it doesn’t count.
– A trade copying service, using outside investment managers and retirement plan accounts don’t count for TTS.

If you qualify for TTS, claim it by using business expense treatment rather than investment expenses. TTS does not require an election, but 475 does.

In 1997, Congress recognized the growth of online trading when it expanded Section 475 from dealers to traders in securities and commodities. It was when I created GreenTraderTax, urging clients and followers in chat rooms to elect 475 for free tax-loss insurance. When the tech bubble burst in 2000, those that followed my advice were happy to get significant tax refunds on their ordinary business losses with NOL carrybacks. I wish Section 475 were openly available to all TTS coin traders now.

Darren Neuschwander CPA contributed to this blog post.

 

Cryptocurrency Traders Owe Massive Taxes For 2017

January 1, 2018 | By: Robert A. Green, CPA | Read it on

I consulted dozens of cryptocurrency (coin) traders on taxes in December and confirmed what the media has been reporting: Coin traders made fortunes in 2017. Now that the 2017 tax-filing season is underway, these traders should gather online tax reports if available, use a coin trade accounting program, and review the latest guidance on tax treatment.

Coinbase has a new online tax report
On July 6, 2017, the IRS narrowed its summons against Coinbase, the most substantial U.S.-based coin exchange, to retrieve larger customers’ trades and other transactions to find unreported income. In late-December 2017, Coinbase added tax reporting of capital gains and losses using first in first out (FIFO). This move should undoubtedly please the IRS since there is no 1099-B issuance on coin trades.

Update Feb. 2, 2018: Coinbase issued 2017 Form 1099-Ks to “qualifying customers,” including businesses, and traders, over specific volume thresholds. (See 1099-K Tax Forms). The IRS intended 1099-K for businesses (merchants) to report Payment Card and Third Party Network Transactions. (See Understanding Your Form 1099-K.)

Capital gains and losses
If you invested in cryptocurrencies and sold, exchanged, or spent it in 2017, you have to report a capital gain or loss on each transaction, including coin-to-currency sales, coin-to-coin trades, and purchases of goods or services using a coin. Deduct coin fees and other expenses appropriately.

Some coin deals naturally generate taxable income, including coin-to-currency trades and mining income. For example, Bitcoin sold for U.S. dollars is a noticeable capital gain or loss reportable on Form 8949. Or, when a coin miner receives a coin for his work, he or she naturally recognizes business revenue based on the value of the coin.

Imputed income
The big problem for the IRS is that most other coin transactions are not evident for tax reporting, including coin-to-coin trades, hard forks (chain splits), and using a coin to purchase goods and services. The coin investor should “impute” a sales or exchange transaction to report a capital gain or loss on coin-to-coin trades and using a coin to purchase items. Many coin investors and their accountants overlook or mishandle this reporting and underpay the IRS.

The IRS labels coin “intangible property.” Coin users may call it “digital money,” but it’s not sovereign government-issued money. That’s the critical difference: Each use of money is not a taxable event. Imagine having to report a capital gain or loss every time you purchased an item or asset with cash or a credit card. That would be ridiculous.

Coin-to-currency trades
Most taxpayers comprehend that if they purchased Bitcoin in 2016 for $10,000 and sold in 2017 for $30,000, they should report a capital gain of $20,000 on their 2017 tax return form 8949. A coin position held for one year or less is considered a short-term capital gain, taxed at ordinary tax rates (up to 39.6% for 2017 and 37% for 2018). A coin position held for more than one year is considered a long-term capital gain, taxed at capital gains rates (up to 20% for 2017 and 2018).

Capital losses offset capital gains in full, and a net capital loss is limited to $3,000 against other types of income on an individual tax return. An excess capital loss is carried forward to the subsequent tax year(s), and it may not be carried back to a prior year. Some coin traders will pay massive taxes on capital gains in 2017 and get stuck with a capital loss limitation and carryover in 2018.

Coin-to-coin trades
Many coin traders actively make coin-to-coin trades like Bitcoin to Ethereum and then Ethereum to Litecoin. Currently, coin investors purchase alt coins using Bitcoin or Ethereum.

Many taxpayers and preparers delay capital gains income on coin-to-coin trades by inappropriately classifying them as Section 1031 “like-kind exchanges,” where they may defer income to the replacement position’s cost basis. While the IRS hasn’t provided guidance on this matter, I do not believe the majority of coin-to-coin trades made on coin exchanges qualify for Section 1031 transactions as they fail one or both of the two primary requirements (and both are required). First, Bitcoin may not be a like-kind property with Ethereum. Second, coin-to-coin trades executed on coin exchanges do not constitute a direct two-party exchange, and coin exchanges are likely not qualified intermediaries in a multi-party exchange.

Coin-to-coin trading reminds me of forex trading between different currency pairs. Various currencies are not like-kind property (i.e., U.S. dollars are not a like-kind property with euros). Each coin has its version of a blockchain, and the network of users has a different purpose for each coin.

I asked coin tax expert Jim Calvin, Partner of Deloitte and author of When (and If) Income is Realized from Bitcoin Chain-Splits, if he thought these trades could qualify for Section 1031 like-kind exchange treatment in 2017 and prior years.

“It is neither a simple nor single factual issue,” he said. “It is not just whether the swapped coins are like-kind property, but also whether all the other requirements of Section 1031 can be met including the use of intermediaries.”

Atomic swaps or atomic cross-chain trading started in August 2017. The new technology allows a direct two-party exchange, bypassing coin exchanges. That may meet one requirement, but the coins must also be a like-kind property for Section 1031 deferral.

Tax Cuts and Jobs Act and coin traders
Starting in 2018, the Tax Cuts and Jobs Act limits Section 1031 like-kind exchanges to real property, not for sale. Investors may not use it on artwork, collectibles, and other tangible and intangible property, including cryptocurrencies.

The Act introduced Section 199A, a 20% deduction on qualified business income (QBI) in pass-through entities, subject to thresholds, limitations, and haircuts. A trader tax status (TTS) coin trader likely does not qualify for the deduction because he or she has capital gains income, excluded from QBI. This is different from a TTS securities trader who can elect Section 475 MTM ordinary income, which is included in QBI.

Coin hard forks (chain-splits)
The IRS has not provided guidance on hard fork transactions, and tax experts and coin traders debate its tax treatment. Bitcoin had a hard fork in its blockchain on Aug. 1, 2017, dividing into two separate coins: Bitcoin and Bitcoin Cash. Each holder of a Bitcoin unit was entitled to arrange receipt of a unit of Bitcoin Cash. Some Bitcoin holders did not gain immediate access to be able to sell Bitcoin Cash, so they may feel it’s okay to defer income on the fork transaction until they obtain such access, or later sell it. Coinbase did not support Bitcoin Cash when it forked, but it did add it to accounts for rightful holders in late-2017.

It’s reasonable that coin traders should not have to report taxable income on a hard fork until the new coin is time-stamped as a ledger entry, sending the coins to new outputs in the blockchain. Facts and circumstances on hard forks vary widely. An “old fork” could die out if miners collectively switch over to the new blockchain and abandon the old coin. Bitcoin Cash successfully forked from Bitcoin; both trade at higher values today than on the fork date. Hard forks frequently happen, and their initial fair market value varies significantly across coin exchanges.

“Taxable income is realized if the owner of pre-split bitcoin exercises dominion and control over the corresponding chain-split coins, and the income realized will be equal to the value of the chain-split coins at that time,” Calvin said. “Most owners holding Bitcoin on exchanges were unable to control if and when chain-split coins were claimed, the time income was realized, and may still be unaware of the date or value to use.”

I think many Bitcoin Cash holders had dominion and control over the new coin sometime in 2017, and they should recognize ordinary income on receiving it.

Coin trade accounting programs
Coin tax reporting is complex and voluminous. Consider two coin accounting solutions: Bitcoin.Tax and CoinTracking.Info.

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.)

Because the IRS labels coin intangible property, wash-sale loss rules likely don’t apply. TTS traders using Section 475 ordinary gain or loss on securities and/or commodities (Section 1256 contracts) may not use Section 475 on a coin since it’s not a security or a commodity in the eyes of the IRS.

How to deduct coin-trading costs
Coin traders pay various transaction costs, fees, and interest expenses in coin and currency. Be sure to convert coin expenses to U.S. dollars at the time spent. It’s critical to distinguish between tax categories — transaction costs, investment expenses, investment interest expenses, and trading business expenses — as they are all handled differently on tax returns.

Transaction fees can be deducted from sales proceeds and then added to cost basis for purchases, so reflect them on net capital gains and losses. These charges include trading costs (approximately 0.25%) paid to a coin exchange and fees paid to miners when transferring coin between addresses to get transactions into the next block.

The new tax law suspends investment expenses for 2018, but you can still deduct them as a miscellaneous itemized deduction for 2017 (if they are more than 2% of AGI). These costs include bank wire transfer fees for transferring currency to a coin exchange; loan or borrow fees paid to a coin exchange; and withdrawal fees paid to a coin exchange for removing money or coin. (It’s essential to separate loan fees vs. margin interest, as they have different tax treatment.)

Investment interest expense can be an itemized deduction, limited to investment income, with the excess carried over to the subsequent tax year. This includes interest on borrowed funds paid in coin to lender/exchange. The new tax law did not change the rules for investment interest expenses.

Trading business expenses are deducted from gross income. If the coin trader qualifies for TTS, investment expenses and investment interest expenses are deducted as business expenses on Schedule C or through an entity.

Miners deduct business expenses against revenues.

Example: Purchasing goods and services with coin
On Jan. 1, 2017, Joe bought 100 Bitcoins at a price of $998 each, for a total cost basis of $99,800. On June 1, 2017, when the price of a Bitcoin unit was $2,452, Joe used a Bitcoin to purchase a computer for $2,452. Without realizing it, Joe triggered a reportable short-term capital gain on his 2017 Form 8949. The sales proceeds are $2,452, representing the fair market value of the Bitcoin he used to purchase the computer. His cost basis for that one Bitcoin unit used is $998, so his net short-term capital gain is $1,454. If Joe uses the computer in his business, he will deduct $2,452 as an expense.

Bottom line
I suggest coin traders calculate capital gains and losses on coin transactions, including coin-to-coin trades made on exchanges, and use the FIFO accounting method. File an extension by the due date of your tax return (April 17, 2018, for individuals), and pay taxes owed for 2017 with the extension. During the additional time (file by Oct. 15, 2018), perhaps the IRS will answer our questions, including which if any coin-to-coin trades may use Section 1031 deferral in 2017. If the IRS allows it, maybe coin traders can still file that way on an original tax return filing. Consult a coin tax expert.

For more information, see Green’s 2018 Cryptocurrency Tax Guide.

If you have any questions, contact us.

 

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