Cryptocurrency trading was all the rage in 2017 when the markets skyrocketed in price. Many traders made massive capital gains. These markets crashed in 2018, and many taxpayers will suffer capital loss limitations and carryovers. The IRS issued guidance on tax treatment for cryptocurrencies in June of 2014 and said it will issue updated guidance soon. There are open questions about accounting method, wash sales, Section 475, hard fork income, and use of like-kind exchanges before 2018.

Tax reports and 1099-K

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 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. Coinbase and other U.S. coin exchanges issued a Form 1099-K if certain thresholds were met. We expect the same reports and 1099-Ks (Payment Card and Third Party Network Transactions) for 2018. Generally, Form 1099-K is issued to merchants for credit card transactions.

Capital gains and losses

If you invested in cryptocurrencies (coin) and sold, exchanged, or spent it in 2018, you have to report a capital gain or loss on each transaction, including cryptocurrency-to-currency sales, cryptocurrency-to-altcoin trades, and purchases of goods or services using a cryptocurrency. Deduct cryptocurrency fees and other expenses appropriately.

Some cryptocurrency deals naturally generate taxable income, including cryptocurrency-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 cryptocurrency miner receives cryptocurrencies for his work, he naturally recognizes business revenue based on the value of the cryptocurrency received on the date of receipt.

Imputed income

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

Intangible property

The IRS labels cryptocurrency “intangible property.” Cryptocurrency 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/asset with cash or a credit card. That would be ridiculous.

The SEC categorized some Initial Coin Offerings (ICOs) for coins or tokens as “securities,” but it said Bitcoin and Ethereum are not securities. The CFTC referred to cryptocurrencies as commodities falling under their enforcement jurisdiction. However, the IRS has not changed its designation of cryptocurrency as intangible property. That’s important since securities are subject to wash-sale loss rules and only some types of commodities are Section 1256 contracts with lower 60/40 tax rates. A TTS trader might elect Section 475 MTM ordinary gain or loss treatment on securities and/or commodities, but that does not apply to intangible property including cryptocurrencies.

The IRS requires the “specific identification” accounting method for sales or exchanges of intangible property, but that’s difficult to execute for cryptocurrency traders since coin exchanges do not confirm specific identification. In this case, coin traders should use FIFO. The IRS said it would answer this question with updated guidance soon.

Excerpt from Green’s 2019 Trader Tax Guide. We have an entire chapter 18 on cryptocurrencies.