Updated IRS Tax Guidance!
After hitting my two-year anniversary on Steemit, I was starting to think this day would never come! Today, the IRS released updated tax guidance:
- Frequently Asked Questions on Virtual Currency Transactions
- Revenue Ruling 2019-24 Addressing Hard Forks
Below is a summary of some key updates. Personally, I (and many other tax advisors) will need time to digest, and I will need time go through and edit/annotate the previous installments of the Crypto Tax E-Book.
Applicability
The FAQ is very general and only applies to "capital asset" transactions.
It's unclear whether assets received from mining/staking are capital assets as well, and this is a point that I have addressed in the e-book, but let's assume for now that mined/staked crypto are capital assets and the guidance in the FAQ is relevant. The word "mining" and "mine" are excluded from the FAQ altogether which is odd to me, since it was discussed in the original Notice 2014-21.
Also, it appears the intent of the FAQ is to address general tax principles. However, the authority of the FAQ would not be able to override a code section, regulation, court case or ruling. The tax treatment of ICO/STOs, etc. is not addressed in relation to applicable nonrecognition provisions that could apply to a capital formation/raise transaction under U.S. tax principles. The Revenue Ruling 2019-24 related to forks can be considered a higher level of authority than a general FAQ (although it seems this could all have been released on a Revenue Ruling vs. just the forks topic).
The first thing people noticed is the IRS uses the word "airdrop" out of the traditional context in the crypto space. The fork guidance in the Revenue Ruling is for forks such as Bitcoin Cash derived from Bitcoin.
Liked Kind Exchanges, Deminis Rule?
If property is exchanged for virtual currency, or virtual currency is exchanged for other virtual currency, or virtual currency is exchanged for other property, the taxpayer will recognize a capital gain or loss - see Q&A 15 and 17. The IRS did not address whether pre-2018 trades qualified as like-kind exchanges.
The IRS did not create a deminimis rule for small crypto transactions, such as crypto spent on goods/services. Using crypto for goods/services would generally be a capital gain transaction. See Q&A 13 and 15. The IRS FAQ seemingly implies that a loss would be a deductible capital loss, and does not address whether the loss would be disallowed as "personal" if derived from a wallet that is held exclusively for consumer transactions (i.e. the Flexa SPEDN App).
Valuation in General, Phantom Income for Service Providers of "Newer" Projects
A cryptocurrency fair market value is determined as follows:
- If crypto is received in a transaction on an exchange (i.e. BTC-ETH on Binance), the value of the crypto is that USD value reported by the exchange. This applies if the transaction occurred on-chain or off-chain (i.e. crediting different users' accounts for the trade versus moving coins on-chain to user addresses). See Q&A 25
- If crypto is received in a peer-to-peer or non-exchange transaction, the IRS will accept a cryptocurrency explorer that analyzes various indices of cryptocurrency at an exact date or time. Otherwise, if this is not used, then the taxpayer must make their own representations on value. This is a practical issue for those using close date values from Coin Market Cap instead of exact time-stamps, so it seems the IRS may have missed the boat on the practical challenges of their mandate. See Q&A 26
- If a taxpayer receipts crypto that does not have a published value (i.e. not listed on an exchange), the value of that crypto is determined in reference to the value of the property given up in the exchange, or the value of the services provided. See Q&A 27.
Q&A 27 – creates potential phantom income for miners/stakers engaging in new projects that are not exchange-traded crypto assets. For example: a miner allocates 1000 KSOL of hash power to Zcash, and assume that the "service" of mining is compensated with $100 per day in ZEC coins. If a new project spins up using a fork of ZEC (genesis fork), and the miner uses 1000 KSOL to mine the new network project's coin, before it’s traded on an exchange, the mining revenue is economically $0 as the coin is worthless. However, for IRS purposes the value should be calculated based on the “value of the service provided," which the IRS may argue is $100 per day. It's possible this has implications for new project pre-mines as well, and service providers of new projects who have an hourly rate but take crypto instead. It's effectively a "bartering" concept.
Forks
Under Revenue Ruling 2019-24, a taxpayer has ordinary income upon receipt of the new currency in a crypto hard fork, at the time when the taxpayer receives the currency (i.e. when dominion/control over the new forked assets are obtained):
- If a hard fork does not result in a new, separate coin to the holder of the old coin, there is no income to the holder of the old coin. So all genesis-block style forks do not have implications to the old chain's users. See Situation #1 of the Ruling.
- The IRS ruling uses the word "airdrop" to mean when a new coin is created from a fork (i.e. BCH derived from BTC, ETC derived from ETH, etc.). The forked coin is taxable to the recipient when received. See Situation #2 of the ruling.
- Practically, the fair value at the time of receipt is minimal/low if the forked coin is not immediately trading on an exchange. However, if forked coins are on an exchange and then later credited to a traders account (i.e. getting a fork deposited on Binance), then the date of the credit to the account may be when the taxpayer is deemed to "Receive" the forked currency. This may have implications RE: the 2017 BCH fork becoming available on Coinbase at a Very high valuation.
- ER 20 conversions to main-net tokens (i.e. EOS) are not intended to be covered by this ruling, as such transaction doesn't result in two separate digital assets.
Basis
If a taxpayer owns multiple units of one virtual currency, acquired at different times, a taxpayer may track basis on a sale using the following methods:
- Use "specific identification" to choose which units of currency are deemed to be transacted for purposes of determining cost basis. See Q&A 36.
- Use a FIFO method. See Q&A 38.
Specific Identification
Cost basis is generally determined under the "specific identification method" by using a unique digital identifier:
- A private key, public key and address or
- Records showing the transaction information for all units of a specific virtual currency in a single account/wallet/address.
It would be absolutely foolish to provide a tax advisor or the IRS with a private key. The IRS misses the boat that the public key and address without the private key is sufficient to accomplish a unique identifier.
Further, the specific identification method is relatively strict, the following information must be in the records:
- Date and Time each unit was acquired
- Taxpayer's basis and fair market value of each unit at the time acquired in #1.
- Date and time of sale of the unit
4a. Fair value of each unit sold/exchanged, and
4b. The value of property (i.e. including a different crypto) or money received in exchange.
Practically, this information can be found in block explorers for mining income, in exchange reports, and possibly even upon import into a software solution. It is critical that the assets acquired are traced to the specific transaction of the sale, which some of this trail possibly gets lost after the import if the software solution is applying a sale method on an aggregate basis, it's possible that this causes a taint to the "specific ID" method.
First in First Out
The First in First Out (FIFO) method is determined by treating the earliest assets acquired as the earliest assets disposed. In other words, the last assets acquired are treated as still in the taxpayers inventory at year-end. Countless crypto software solutions default to this method. This is best explained via an example:
Example: A taxpayer acquires 1 Bitcoin on 1/1/2019 for $3,000 and 1 Bitcoin on 6/1/2019 for $10,000. On 9/30/2019, taxpayer sells 1.5 Bitcoin for $12,000 ($8k per coin). If the FIFO method is used.
For the gain on the sale:
- The entire 1 Bitcoin acquired on 1/1/2019 is treated as disposed first with a basis of $3,000 and a sales price of $8,000 (1/1.5 BTC X $12,000 total sale), gain of $5,000
- 0.5 Bitcoin of the lot acquired on 6/1/2019 is treated as disposed with a basis of $5,000(0.5/1 BTC X $10,000 total purchased) and a sales price of $4,000(0.5/1.5 BTC X $12,000 total sale), loss of ($1,000).
- Net gain on the transaction is $4,000 .
For the position at year-end:
- Remaining asset - 0.5 BTC acquired on 6/1/2019 with a basis of $5,000 (0.5/1 BTC X $10,000 total purchased).
Other Methods
Taxpayers who took a position other than that above should evaluate if a specific identification method would have been close to the method utilized, and/or whether to amend the tax filings using a FIFO method or specific identification method.
Takeaway
There are more topics to cover, such as recordkeeping, "gifts" and "charitable contributions." This will be covered in a Part 2 installment. Further, the E-Book will eventually be updated to reference the new guidance.
Picture Credit
https://pixabay.com/photos/income-tax-calculator-accounting-4097292/
Links to Guidance
https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
https://www.irs.gov/pub/irs-drop/rr-19-24.pdf
https://www.irs.gov/pub/irs-drop/n-14-21.pdf
Disclaimer: This series contains general discussion of U.S. taxes in a developing and unclear area of tax law. As always, you should consult your own tax advisor in your jurisdiction to determine your specific situation as this is not personal advice; and consider any future guidance by the Congress/IRS after the date of this article. Under Circular 230 to the extent it applies, this article cannot be used or relied on to avoid any tax or penalties in the U.S., its States or any other jurisdictions. This post does not create a client relationship between the author and the reader.