It is safe to assume that all exchanges in cryptocurrencies will now be taxable.
If you are and were a long-term investor, then it will be easy to figure out cost basis. Whenever you transact with the crypto currency you will have to pay the tax when the exchange takes place. These are new changes because of the new rules under the 1031 exchange.
The traders that will have the most issues will be short-term investor (day traders, swing traders, etc.). This is because each transaction, even different exchanges are used, are going to be taxable under the new revisions so the law. Since there will be no 1099’s issued it will be the responsibility of the investors to monitor and report the capital gains on their income tax returns. If you have trade, exchange, and invest in bitcoin (or any other crypto) please start a journal of all crypto acquisitions in order to calculate your cost basis.
Example: The reference price I’ll use is taken from my last bitcoin blog post.
- Bob purchases 5 bitcoins (BTC) for the price of $4,200. His initial investment is $21,000. (This example does not include transaction fees and mining costs)
- The current BTC price (as of January 2018) is roughly floating around $15,000. Let’s say Bob’s investment is now worth $75,000. Bob decides cash in and decides to avoid the high fees by finding someone who will exchange their car worth $75,000 for 5 BTC.
- When Bob files his 2018 return next year he’ll have to report, and pay a tax, on a capital gain of approx. $54,000 (75k value – 21k initial investment) on his Schedule D.
- If he were to buy 1 BTC at $4,200, 1/2 a BTC at $4,500 (you can buy partial coins), and 3.5 BTC $5,500, his cost basis will be different and will have to report a different amount.
I feel this excerpt helps understanding where the confusion originates. When it comes to the IRS, I don’t need to tell you about the risk of not reporting correctly.
Cryptocurrencies may not qualify as like-kind property
If it’s not like-kind property, it’s not a like-kind exchange. Section 1031 specifically excludes stocks, bonds, notes, and indebtedness. It does not mention “cryptocurrency” or “virtual currency” since Section 1031 predated the advent of cryptocurrencies.
“Transactions for two biggest cryptocurrencies, Bitcoin and Ethereum, are priced in different ways, and there are other fundamental differences, too,” says Darren Neuschwander, CPA.
The IRS could rule they are not like-kind property. It’s interesting to see how the IRS ruled on like-kind exchanges between coins and bullion. (Read Bitcoin taxation: Clarity and mystery. See the discussion of Section 1031 and the chart “Sec. 1031 rulings involving coins and bullion.”) In some cases, exchanges of gold for gold coins or silver for silver coins may qualify as like-kind property, but gold for silver coins is not like-kind property. An exchange of U.S. gold coins for South African Krugerrand gold coins was not like-kind property because the coins have a different composition. Krugerrands are bullion-type coins whose value is determined solely by metal content, where the U.S. gold coins are numismatic coins whose value depends on age, condition, number minted, and artistic merit, as well as metal content.
IRS hasn’t addressed Section 1031 on cryptocurrencies
In March 2014, the IRS issued long-awaited guidance (IRS Notice 2014-21) labeling cryptocurrency “intangible property,” but the IRS did not address the use of Section 1031. Investors and traders hold Bitcoin as a capital asset, so it receives capital gain and loss treatment. The AICPA and others requested further guidance from the IRS, including if investors could use Section 1031. The IRS has not yet answered in public.
With a lack of IRS guidance, using Section 1031 on cryptocurrency trades is uncertain, and I suggest wrong in almost all facts and circumstances. There is no “substantial authority” for its use, which would be required to avoid tax penalties.