Bitcoin and the IRS
Bitcoin and the IRS tax season is right around the corner, taxpayers might be feeling a bit uneasy. The money generated by the bitcoin cash hard fork has played a role in driving bitcoin’s price surge. However it’s not all fun and games. Bitcoin owners have effectively acquired value for free, but there is still a cost associated with the assets. Moreover it could happen again if there is the Bitcoin Gold fork November 12th.
According to Carla DeWitt CPA, for tax reporting purposes, the IRS currently classifies bitcoin and “other virtual currencies” as property. Meaning owners are legally obliged to report the capital gains and losses incurred from cryptocurrency holdings during each calendar year.
“From a tax perspective, the bitcoin hard fork really is uncharted territory,” said James Markwood. James Markwood is a tax attorney with Cogent Law Group in Washington. D.C.
“There are really two choices, and neither one of the choices are particularly appealing,” said Woodin.
Bitcoin and the IRS Options
The first choice is to assign each new coin an arbitrary value to use as its cost basis. This could potentially be done by taking a weighted average. Bitcoin cash’s trading value in futures markets just before the August fork. Or by assigning it a value proportional to that of a full bitcoin.
Any increase in the price after the cryptocurrency’s inception and before the end of the year would then be subject to capital gains tax.
The other possibility is to assign the new coin an arbitrary value of zero and then pay the capital gains tax on the full value whenever the disposition of the coin occurs (when they are exchanged for other crypto assets or for fiat currency).
The latter approach would seem to match up with the IRS‘ thinking on other types of second-generation assets, explained Markwood, noting the situation could be similar to that of a farmer who owns a cow that gives birth to a calf or a landowner who discovers gold on his property.
Importantly, in both cases, the creation or discovery of the new asset would not necessarily trigger a taxable event. But when the assets are sold off, the full value of the disposition would be deemed taxable income.
While the latter approach may seem more appealing to bitcoin owners because it allows them to effectively kick the can until they sell an asset, it’s unclear whether or not that applies to cryptocurrencies.
Of course, a third option, not recommended, is to simply ignore one’s reporting obligations altogether, a strategy that – as evidenced by the IRS’s assertion that only 802 individuals reported capital gains from bitcoin in 2015 – has been employed quite frequently by U.S. traders.
Higher risk in 2017
Crypto tax-evaders face much higher risk in 2017 as the skyrocketing value of bitcoin and the newly created class of crypto millionaires are drawing scrutiny from the authorities. An absolute is the new assets being created by bitcoin forks underscore the need for greater clarity from the IRS on how cryptocurrencies should be reported for tax purposes.
Many in the industry have asked the IRS for more formal guidance – the Cryptocurrency Tax Fairness Act was introduced in Congress in an attempt to push the IRS to revisit its determination – but the IRS has yet to release an update.
According to Amy Davine Kim, global policy director and general counsel at the Chamber of Digital Commerce:
“Forks represent just one example of activities on a blockchain that may have tax consequences that, with little guidance from the IRS, are difficult to determine.”
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