Tag Archives: cryptocurrencies

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. 

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.