By Mikhail Charles
Pupil Barrister (England and Wales)
Barrister (British Virgin Islands, St. Kitts and Nevis, St. Vincent, St. Lucia, Grenada)
Team Member HTJ.Tax
DEDUCTING LOSSES GENERALLY
Generally, any loss sustained during a tax year in connection with a trade or business or in a transaction entered into for profit is deductible under Internal Revenue Code (Code) Section 165 unless it is compensated for by insurance or otherwise. A loss is treated as sustained during the tax year in which the loss occurs if it is evidenced by closed and completed transactions, fixed by identifiable events, and, with certain limited exceptions, is actually sustained during the tax year. A loss is not sustained to the extent there exists a claim for reimbursement—if there is a reasonable prospect of recovery—until the tax year during which it can be ascertained with reasonable certainty that the claimed reimbursement will not be received. No deduction is permitted if the loss arises solely as a result of a decline in the value of property owned by the taxpayer due to market fluctuations or other similar causes. However, a loss arising from theft in connection with a trade or business or in a transaction entered into for profit is permitted and is treated as sustained during the tax year in which the taxpayer discovers the loss (provided that no claim for reimbursement exists). Theft includes embezzlement, robbery and larceny, among other items.
If any “security” that is a capital asset becomes worthless during the tax year, the resulting loss is treated as a loss from the sale or exchange of a capital asset on the last day of the tax year. A security for this purpose means a share of stock in a corporation; a right to subscribe for or to receive a share of stock in a corporation; or a bond, debenture, note, certificate or other evidence of indebtedness issued with interest coupons in registered form by a corporation, a government or a governmental political subdivision.
Abandonment losses incurred in a trade or business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in the trade or business or the transaction of any non-depreciable property can also give rise to a deduction if such business or transaction is discontinued or where such property is permanently discarded from use therein. To prove permanent abandonment, a taxpayer must show evidence of an intention to abandon the property and an affirmative act of abandonment.
For individual investors that purchased cryptocurrency for personal investment purposes, losses from worthlessness or abandonment are classified as miscellaneous itemized deductions. However, under current law, losses characterized as miscellaneous itemized deductions are disallowed for tax years beginning after December 31, 2017, and before January 1, 2026. Accordingly, even if a taxpayer can establish losses for worthlessness or abandonment before 2026, the deduction would be disallowed. In contrast, losses relating to theft (in connection with a trade or business or in a transaction entered into for profit) and wagering are not classified as miscellaneous deductions and would not be disallowed.
IRS GUIDANCE ON CRYPTOCURRENCY AND LOSS DEDUCTIONS
The memorandum considers a fact pattern where a taxpayer purchased cryptocurrency in 2022 for personal investment purposes. After the taxpayer acquired the cryptocurrency, its value decreased significantly to the point where its value was less than one cent at the end of 2022, though the cryptocurrency continued to be traded on at least one cryptocurrency exchange. The taxpayer maintained dominion and control over the cryptocurrency, including having the ability to sell, exchange or transfer it. The taxpayer claimed a deduction on his or her 2022 tax return and took the position that the cryptocurrency was either worthless or abandoned.
The IRS stated that while the cryptocurrency had substantially decreased in value, there was no deductible loss because its value was greater than zero, it continued to be traded on at least one cryptocurrency exchange and the taxpayer did not sell, exchange or otherwise dispose of the cryptocurrency. The IRS relied on existing case law that states that the “mere diminution in value of property does not create a deductible loss. An economic loss in value of property must be determined by the permanent closing of a transaction with respect to the property. A decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as abandonment, sale, or exchange.” Additional case law states that there must be an identifiable event that supports the fact that there is no current liquidating value and no value to be acquired in the future. Because the cryptocurrency still had a liquidating value (even if it was valued at less than one cent) and because it was still possible for the value to increase in the future given that it was traded on at least one cryptocurrency exchange, the cryptocurrency in question was not wholly worthless during 2022 as a result of its decline in value and the taxpayer did not sustain a bona fide loss under Code Section 165(a) because of worthlessness.
To claim a loss under Code Section 165 for abandoned property, (1) the loss must be incurred in a trade or business or in a transaction entered into for profit, (2) the loss must arise from the sudden termination of usefulness in the trade, business or transaction and (3) the property must be permanently discarded from use or from a transaction that is discontinued. The IRS determined that the taxpayer did not abandon the cryptocurrency in 2022 for Code Section 165(a) purposes because the taxpayer did not take any action to abandon and permanently discard the cryptocurrency. The taxpayer also did not demonstrate an intent to abandon the property nor did the taxpayer demonstrate any affirmative act of abandonment.
Instead, the taxpayer maintained ownership of the cryptocurrency through the end of 2022 and retained the ability to sell, exchange or otherwise dispose of the cryptocurrency. Furthermore, the taxpayer continued to exert dominion and control over the cryptocurrency and, regardless of intent, did not take any affirmative steps to abandon the property during 2022.
LIMITATIONS ON THE SCOPE OF IRS GUIDANCE
This guidance takes the form of a Chief Counsel Advice Memorandum, which is generally issued to lawyers and revenue agents within the IRS. The memorandum has no precedential value and cannot be relied on by taxpayers (or cited as precedent). Nonetheless, many taxpayers take such guidance into account as it is useful for understanding the IRS’s current position on a certain issue, particularly when there is no other guidance available. The IRS could adopt a different position on the same or a similar issue and such a position would not require the withdrawal of the memorandum.
PATHWAY TO A DEDUCTION
Since miscellaneous itemized deductions may be available again in the future, taxpayers may still wish to know how these deductions can be claimed. The memorandum provides that, in order for a taxpayer to take a deduction on a tax return for a loss under Code Section 165, the taxpayer must show evidence of either (1) an identifiable event that supports the fact that there is no current liquidating value of the applicable cryptocurrency or any possibility for future appreciation or (2) intent to abandon the cryptocurrency, coupled with an affirmative act of abandonment.
In the last 12 months, many cryptocurrency protocols have been subject to exploits and hacks that have left taxpayers with losses due to theft exceeding $2 billion (e.g., the Ronin bridge hack and the Wormhole bridge exploit). During the same period, several cryptocurrency exchanges filed for Chapter 11 bankruptcy protection in the United States. With respect to theft losses (in connection with a trade or business or in a transaction entered into for profit), provided that such taxpayers can show evidence of the theft and the amount of loss and are not entitled to receive any reimbursement through insurance or otherwise, such taxpayers may be able to deduct such losses on their tax returns. However, with respect to the cryptocurrency exchanges that are currently going through the Chapter 11 bankruptcy process, the answer is less clear given the uncertainty as to whether such taxpayers are entitled to reimbursement (e.g., as a creditor).
The most common way to abandon cryptocurrency is to send it to a null address (also known as a burn address), which takes the cryptocurrency out of circulation so it cannot be used by any person going forward. Such action should be treated as evidence supporting forfeiting of dominion and control over the cryptocurrency. Other methods of abandonment could involve transferring a taxpayer’s right (or claim) to receive any currency to another party.
While the memorandum is helpful in providing insight into how the IRS is considering guidance related to cryptocurrency, given the limited facts, questions remain with respect to whether a taxpayer can claim a loss deduction for cryptocurrency losses. For example, the memorandum does not provide any discussion regarding the tax consequences of a taxpayer that does not have the ability to abandon (or take other action with respect to) the cryptocurrency since it is either frozen on a cryptocurrency exchange (e.g., in the case of a cryptocurrency exchange undergoing the Chapter 11 bankruptcy process that has suspended withdrawals and/or other actions) or is traded on a decentralized exchange without any available liquidity.
While existing guidance provides that Bitcoin and Ethereum are likely to be treated as commodities because futures on these cryptocurrencies are traded on a commodities exchange, other cryptocurrencies may be treated as securities. On March 28, 2022, the US Department of the Treasury (Treasury) released the Fiscal Year 2023 Revenue Proposals and Green Book, which extended the definition of security to include actively traded digital assets that are recorded on cryptographically secured distributed ledgers in other areas of the Code (e.g., loans of securities under Code Section 1058). Given the recent events of the overall cryptocurrency industry, the Treasury may consider extending the expansion of the definition of security to Code Section 165, however, no indication has been made.
The IRS has recently issued several memoranda on topics related to cryptocurrency and representatives of the IRS have indicated that further guidance is forthcoming.
Original Article published February 2022
Any U.S. citizen that dabbled in cryptocurrency over the 2021 tax year will now be expected to file a tax return to the IRS. Taxpayers can file their taxes between Jan. 24 and the April 18 deadline, with penalties issued for submissions made beyond the deadline.
Cryptocurrencies, including non-fungible tokens (NFTs), continue to be treated as “property” for the purposes of tax in the United States.
The IRS published initial guidance on the taxation of transactions using virtual currency in IRS Notice 2014-21 (so over 8 years ago, this means that a majority of taxable actions involving digital assets will incur capital gains tax treatment, similar to how stocks are taxed), this is still the position.
Like other jurisdictions the IRS defines virtual currency as a digital representation of value (other than a representation of the US dollar or a foreign currency) that functions as a unit of account, store of value, and a medium of exchange.
- Convertible virtual currency is treated as property (and not currency). This means that the rules that apply to foreign currencies (and that can cause foreign currency gain or loss for US tax purposes from transactions in foreign currencies) do not apply.
- Transactions in convertible virtual currency can generate gain or loss for US tax purposes.
Examples of transactions in convertible virtual currency that can generate income, gain, or loss include:
- Receipt of convertible virtual currency as payment for goods or services. In computing gross income from the payment, the recipient must include the fair market value of the virtual currency, measured in US dollars, on the date of payment. This can include, for example, virtual currency paid by an employer to an employee as wages (with wages subject to income tax withholding and payroll taxes).
- Using the convertible virtual currency to buy other property. For example, using Bitcoin to buy a sandwich could trigger taxable gain or loss.
- Exchanging one convertible virtual currency for another virtual currency. The current position is that Section 1031 only applies to exchanges of real property.
- Selling the virtual currency for US dollars (or another real currency).
Because convertible currency is treated as property, general tax rules that apply to transactions in stocks, bonds, and other investment property generally apply. The character of any gain or loss on the exchange of convertible virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer, which will generally be the case for a taxpayer that invests in or trades virtual currency. Gain or loss from a convertible virtual currency transaction may be ordinary income or loss if the taxpayer is considered to be a dealer in the virtual currency (for example, if the virtual currency is considered part of the taxpayer’s inventory, see IRC Section 1221(a)(1)).
There is typically a dearth of case law in respect of the tax treatment of crypto either at the state or federal levels however we have collated a list of recent regulatory decisions and court decisions to assist.
Here at HTJ Tax, we typically handle 6,7 and 8 figure individuals and companies who engage in the business of cryptoassets, and we can do no better than adopting Rees and Streisand (when we speak to our clients), they suggest that a deep dive on a particular cryptoasset investment being considered needs to be undertaken. 1AF Streisand & JD Rees, “Cryptocurrencies and Trustees Duties to Invest Prudently: Navigating Fiduciary Duties in the Age of Decentralization” (2018) 24(3) California Trusts and Estates Quarterly 11 at 20.
They propose that in evaluating an investment, the trustees need to consider inter alia the following questions:
(a) What is the problem the cryptoasset is addressing?;
(b) What is the proposed solution to the problem?;
(c) Who is on the management team?;
(d) How large is the market?;
(e) Are there any existing competitors?
(f) What is the business plan?;
(g) How will investors see a return on investments?
(h) How transparent is the management team?; and
(i) How likely is the product to achieve critical mass?
All these are certainly sensible questions in evaluating an investment into cryptoassets.
HTJ Tax is accustomed to being deployed pre-, post- and during investment into cryptoassets.
How does US Law classify ‘crypto’?
Cryptocurrency blockchains, such as bitcoin, are often set up so that there is no record of the identity of the owner of a particular token. Cryptocurrencies can have features that do not fit well into the existing legal framework for property ownership and transfer. Even determining whether a cryptocurrency token is property (for purposes of the UCC and otherwise) and, if it is, which party owns that property is not straightforward.
If a lender is taking a security interest in cryptocurrency assets, the lender must consider the risk that the purported owner of the asset cannot be recognized by a court as the owner as well as the possibility that cryptocurrency assets may be determined not to be personal property at all and therefore not subject to Article 9 of the UCC.
In the US, state law is typically the basis for determining ownership of most types of property, although federal law may control in certain cases. In California, for example, the standard for determining whether a property right exists is as follows:
”First, there must be an interest capable of precise definition; second, it must be capable of exclusive possession or control; and third, the putative owner must have established a legitimate claim to exclusivity.”
(G.S. Rasmussen & Assocs., Inc. v. Kalitta Flying Serv., Inc., 958 F.2d 896, 903-04 (9th Cir. 1992).)
The first of the three criteria above (”an interest capable of precise definition”) is met regarding cryptocurrency tokens. There are a specific number of tokens in existence at any point in time and the ledger shows the distribution of those tokens.
The second of these criteria (” capable of exclusive possession or control”) appears to be met as well. A user needs to know the relevant private key to move tokens from a particular address.
However, meeting the third of the criteria (establishing a “legitimate claim to exclusivity”) seems more difficult. As noted above, there is no definitive registry of real-world identities of owners of a given address. The ability to exercise exclusive control of tokens at an address is based on actual knowledge of a given private key. It may be argued that a party can claim exclusivity by demonstrating the ability to move tokens out of an address by using a private key, but this does not prove that no one else can do this.
Even if a user of a cryptocurrency may prove that the user created an address, there is no way to prove that only that user has exclusive access to a particular private key for that address. Therefore, while a user may be able to prove that the user can control the tokens at an address by using the appropriate private key to transfer tokens to another address, it is impossible for that user to prove that it is the only party that may do so. The user could have shared the private key with other parties, sold control of the address to a third party, or the private key may have been stolen. While it is true that there is a risk of duplication of physical keys to physical vaults as well, in the cryptocurrency context these risks are far greater; there are no physical objects or physical locations to safeguard, only information.
A word on whether the CFTC can have jurisdiction over crypto assets in the same way as securities. The locus classicus for determining a security is the “Howey” test. 2Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293 (1946)
It is a test to be used in determining whether an “investment contract” exists is: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit and (4) to be derived from the efforts of others.
If the crypto asset meets the Howey test of an “investment contract”, then it is a “security” and subject to regulation by the SEC as such. The determination of whether a crypto asset is an “investment contract” lies primarily in whether it satisfies the “expectation of profit to be derived from the efforts of others” prongs under the Howey Test, since the “investment of money” and “common enterprise” tests are easily met.
But the test’s application is hazy at best:
In Balestra v. ATBCOIN LLC, a federal court in the Southern District of New York held that the cryptocurrency ATB Coin could be considered a security because its investors expected a profit from their investment and relied upon the coin’s promoters for guidance.
The Balestra Court held that ATB Coin met the second element of the Howey Test, common enterprise, could be met because Plaintiffs had plausibly alleged that “potential profits stemming from the future valuation of the ATB Coins were entirely reliant on the success of Defendants’ new blockchain.”
“Defendants encouraged investors to purchase ATB Coins based on the claim that the speed and efficiency of the ATB Blockchain would result in an increase in the coins’ value.” Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340, 354 (S.D.N.Y. 2019).
The Balestra Court also held that ATB Coin met third prong of The Howey Test, the expectation of profits, was met because “purchasers of ATB Coins reasonably believed that those coins would increase in value based primarily on Defendants’ entrepreneurial and managerial efforts.” Id.
Critically, however, the Court found that ATB coin did not operate on a decentralized system, such as Ethereum or Bitcoin, but instead resembled a more centralized investment fund.
Although this decision should put coin proprietors on notice that they may be exposed to civil suits from investors, the SEC has also consistently hinted that it does not consider decentralized cryptocurrencies to be securities.
- Coinbase in particular has confirmed they send Form 1099-MISC to any investor who made more than $600 in a financial year and that they send this form to both the investor and the IRS. Note that the reality is any crypto exchanges that uses Know Your Customer (KYC) identification may be asked to share this information with the IRS. The IRS is using this information to send out letters to American crypto investors to remind them to report their crypto transactions and pay their crypto taxes, as well as to conduct audits and seize assets from those avoiding taxes.
- There isn’t a specific crypto tax rate. It’s all based off the Capital Gains Tax rules. The Capital Gains Tax rate you’ll pay on your crypto depends on how long you’ve held your asset for and how much you earn. If you’ve held it for less than a year, you’ll pay the short-term Capital Gains Tax rate. If you’ve held it for more than a year, you’ll pay the long-term Capital Gains Tax rate, see rates below:
- You can gift up to $15,000 in crypto per person tax-free. This is known as the annual gift tax exclusion. This can help you take advantage of lower Income Tax rates in your household to pay less tax overall. Anything over $15,000 will be subject to tax.
- If you earned less than $40,000 in the 2021 financial year – you’ll pay no Capital Gains Tax.
- If you HODL your crypto for more than a year, you’ll pay a lower long-term Capital Gains Tax rate of between 0% to 20% depending on how much you earn.
- You can offset your capital losses against your net capital gain for the year to reduce your tax bill. In the US, there is no limit on how large a capital loss you can write off in any one year, so if you have enough losses, you can write off your entire net capital gain and pay no tax. If you have a larger capital loss than your net capital gain, you can also offset up to $3,000 of capital losses against ordinary income to further reduce your overall tax bill. If you still have more capital losses leftover after doing this, you can carry losses forward to future financial years to offset against future gains. You can carry capital losses forward indefinitely – so until you’ve used them.
- Cryptocurrency is viewed as income instead of a capital gain. This includes: Getting paid in crypto, mining crypto – on a hobby level, receiving an airdrop, receiving new coins from a hard fork, staking rewards and referral bonuses.NOTE: A decision to refund a Nashville couple taxes related to unsold Tezos tokens is set to clarify the IRS tax treatment of staked cryptocurrency. In a win for cryptocurrency stakers and miners, the IRS has offered to refund the couple taxes paid on rewards gained — but not redeemed — from staking on the Tezos blockchain, according to sources familiar with the matter. 3< https://blockworks.co/in-win-for-crypto-stakers-irs-offers-refund-on-untraded-token-rewards/ > Accessed 17 February 2022
This may set a precedent in how the IRS treats with proof of stake crypto assets and the space should be watched closely, the key issue of—whether tokens created through staking represent taxable income at the time of creation, needs proper determination for certainty in the tax space. 4< https://www.hansonbridgett.com/Publications/articles/220207-7270-cryptocurrency-tax > Accessed 17 Feb 2022This may set a precedent in how the IRS treats with proof of stake crypto assets and the space should be watched closely, the key issue of—whether tokens created through staking represent taxable income at the time of creation, needs proper determination for certainty in the tax space. 5< https://www.hansonbridgett.com/Publications/articles/220207-7270-cryptocurrency-tax > Accessed 17 Feb 2022
- Generally, you won’t pay tax on crypto when: Buying crypto with fiat currency, HODLing crypto, moving crypto between your own wallets, gifting crypto under $15,000 in value and donating crypto to charity.
CAUTION:The IRS confirms they’ve been sending out more letters to crypto investors they believe are underreporting or evading tax. Any investors who have crypto assets who did not answer “yes” to the Form 1040 question “at any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” Crypto investors who intentionally underreport their investments can face fines starting from $25,000 and can even face criminal charges with up to 5 years in prison.
- Can a qualifying irrevocable foreign trust provide a planning opportunity in the UK / US?
Yes. The writer thinks that there is some scope for a trust to be used to hold crypto offshore and take some benefit (limited as it be may very well be).
Grantor trust status also applies to a trust from which, at all times by the terms of the trust, no person can benefit during the non-US settlor’s life other than the settlor and/or his spouse. These irrevocable trusts do offer an opportunity for current, tax-free distributions to the settlor and/or his wife. The settlor in particular may then make tax-free gifts to his US beneficiary family
members. This type of trust is especially effective when structured as a completed gift trust as it will also avoid US transfer taxes and can directly acquire for value US estate sited property.
- On the day of a fork, does an owner of the original asset recognize income for the new asset? What if there is no market for the new asset because, say, digital wallets do not support it? And at what value should the adjusted basis be calculated? If it’s the fair market value, at what date: that of the fork or the date on which it can be transacted?
In Revenue Ruling 2019-24, the IRS provided guidance on the tax consequences of hard forks and airdrops. In particular, the IRS determined that:
- When a hard fork occurs resulting in the creation of a new cryptocurrency and a taxpayer does not receive the new cryptocurrency, the taxpayer does not have gross income.
- If a taxpayer owns a cryptocurrency at the time of the hard fork, and receives new cryptocurrency (in addition to the legacy cryptocurrency that the taxpayer retains), the taxpayer has ordinary income in the taxable year in which the new cryptocurrency is received. The amount of ordinary income is the fair market value of the new cryptocurrency on the date the airdrop is recorded on the distributed ledger.
As an example, the IRS has also determined that a taxpayer who received a unit of Bitcoin Cash at the time of the August 2017 hard fork (while retaining a unit of Bitcoin) had gross income in the 2017 taxable year equal to the fair market value of the Bitcoin cash as of the time of the August 1, 2017 hard fork (CCA 202114020).
On the day you receive your new coins, you’ll pay Income Tax. Like with airdrops, to calculate the amount of income, you’ll identify the fair market value of the coins or tokens on the day you received them. This figure is also your cost basis.
When you later spend, sell or swap coins from a hard fork, you’ll pay Capital Gains Tax. Your cost basis to calculate any capital gain or loss is the fair market value of the coins or tokens on the day you received them.
You won’t pay any tax as a result of a soft fork because you don’t receive any new coins or tokens as a result of a soft fork. So you don’t have any income to recognize from a tax perspective.
- In order to tap into the value generated by cryptoassets. How are miners treated?
If a miner successfully mines virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in the miner’s gross income (IRS Notice 2014-21). If a taxpayer’s mining of virtual currency constitutes a trade or business, and the mining activity is not performed as an employee, the net earnings from self-employment resulting from the mining activities are self-employment income subject to self-employment tax.
Any crypto you receive as a result of mining – you’ll pay Income Tax based on the fair market value of the crypto on the day you received it. You’ll also pay Capital Gains Tax if you later sell, swap or spend any crypto you received as a result of mining activities.
- What is the US tax treatment of tokens, ICOs and the transfer of tokenized shares:
To compute gain or loss on a transaction involving convertible virtual currency, the taxpayer must determine its tax basis in the virtual currency:
- For virtual currency acquired with US dollars, the basis would be the amount paid.
- The basis of virtual currency received as payment for goods or services is the fair market value of the virtual currency in US dollars on the day of receipt. If a virtual currency is listed on an exchange (and the exchange rate is determined by market supply and demand), the fair market value of virtual currency is generally determined by converting the virtual currency into US dollars (or another real currency that can be converted into US dollars) at the exchange rate.
Unlike investments in stocks, bonds, and other securities, an individual investor may not receive an IRS Form 1099-B relating to their virtual currency transactions (showing gains, losses, and cost basis), and may need to rely on the investor’s own record keeping to determine any taxable gains or losses. However, beginning in 2024 (and relating to transactions on or after January 1, 2023), brokers will be required to issue 1099-Bs for virtual currency transactions.
Case Law / Regulatory Roundup United States 2021
- Coinbase enforcement action. On March 19, 2021, the CFTC issued an order filing and settling charges against digital asset exchange operator Coinbase Inc., requiring Coinbase to pay a civil monetary penalty of $6.5 million. According to the order, between January 2015 and September 2018, Coinbase recklessly delivered false, misleading, and inaccurate reports concerning transactions in digital assets on the electronic trading platforms that it operated. CFTC Commissioner Stump released a separate statement concurring with the judgment but expressing her position that the CFTC cannot be a “cop on the beat” for cash digital asset exchanges that have not offered any derivatives product regulated by the CFTC.
- BitMEX enforcement action. On August 10, 2021, the CFTC and FinCEN each announced settlement with offshore cryptocurrency derivatives trading platform BitMEX, settling charges BitMEX illegally operated a cryptocurrency trading platform that was accessed by US market participants, as well as related anti-money laundering (AML) violations. According to the CFTC order, from November 2014 through October 1, 2020, BitMEX maintained significant US-based operations and therefore violated the CEA by offering leveraged trading of cryptocurrency derivatives to customers in the US without being approved as a designated contract market (DCM) or a swap execution facility (SEF), and operated as a futures commission merchant (FCM) without CFTC registration, by accepting Bitcoin to margin digital asset derivative transactions and acting as a counterparty to leveraged retail commodity transactions.
- Statement of Commissioner Stump. On August 23, 2021, CFTC Commissioner Dawn Stump released a statement of her position that in order to determine the CFTC’s regulatory authority over digital assets, one should consider whether a futures contract or other derivatives product is involved.
- Kraken enforcement action. On September 28, 2021, the CFTC issued an order filing and settling charges against respondent Payward Ventures, Inc. d/b/a Kraken for illegally offering margined retail commodity transactions in digital assets and failing to register as a futures commission merchant (FCM) in violation of CEA Sections 4(a) and 4d (7 U.S.C. §§ 6(a) and 6d).
- FCM actions against crypto trading platforms. On September 29, 2021, the CFTC filed charges against 12 digital asset and cryptocurrency trading platforms for failing to register as FCMs, and two digital asset platforms for making false claims regarding CFTC registration and NFA membership.
- Tether enforcement action. On October 15, 2021, the CFTC filed and settled charges against Tether Holdings Limited, a British Virgin Islands corporation, Tether Operations Limited, a Hong Kong corporation, Tether Limited, a British Virgin Islands corporation, and Tether International Limited, a British Virgin Islands corporation, collectively doing business as Tether, for making untrue or misleading statements and omissions of material fact in connection with Tether (USDt), its US dollar stablecoin. Note related NYAG action.
- Bitfinex enforcement action. On October 15, 2021, the CFTC filed and settled charges against iFinex Inc., BFXNA Inc., and BFXWW Inc., each incorporated in the British Virgin Islands and collectively doing business as Bitfinex (collectively, Bitfinex respondents) for failing to register as an FCM and violating a prior CFTC order. Note related NYAG action.
- On November 1, 2021, in response to the report on stablecoins issued by the FDIC, OCC, and the President’s Working Group (PWG) on Financial Markets, CFPB Director Rohit Chopra issued a statement on the steps the CFPB plans to take to regulate the stablecoin market. In addition to actively monitoring and preparing for broader consumer adoption of cryptocurrencies, the CFPB plans to work with the Financial Stability Oversight Council (FSOC) to determine whether certain nonbank stablecoin-related activities or entities are systemically important.
- BitMEX. On October 1, 2020, the Acting United States Attorney for the SDNY and the US Federal Bureau of Investigation charged four executives and owners of offshore cryptocurrency derivatives trading platform BitMEX with BSA violations related to their willful failure to establish, implement, and maintain an adequate AML program.
- Cryptocurrency Enforcement Framework (CEF). On October 9, 2020, DOJ published its first cryptocurrency enforcement framework (CEF), which defines VC as “a digital representation of value that, like tradition coin and paper currency, functions as a medium of exchange – i.e., it can be digitally traded or transferred, and can be used for payment or investment purposes.” The CEF also clarifies that DOJ considers VC to be a type of virtual asset that is separate and distinct from digital representations of traditional currencies, securities, and other traditional assets and which does not have legal tender status. The CEF describes how DOJ responds to global cybercrime involving cryptocurrency and provides a list of each US criminal statute it is charged with enforcing and explanation of how cryptocurrency may play a role in violation of that statute.
- Start Options and B2G action. On July 30, 2021, DOJ announced that a California man pleaded guilty in the federal court for the Eastern District of New York for his participation in a coordinated cryptocurrency and securities fraud scheme through purported digital currency platforms and foreign-based financial accounts.
- Helix penalty. On August 18, 2021, Larry Dean Harmon pleaded guilty to a money laundering conspiracy arising from his operation of Helix, a money transmitting business and money laundering service which functioned as a Bitcoin mixer/tumbler by allowing customers to send Bitcoin to recipients in a manner that was designed to conceal the source or owner of the Bitcoin. Helix was linked to and associated with Grams, a Darknet search engine also run by Harmon. Note parallel FinCEN action.
- BitConnect. On September 1, 2021, DOJ announced that Glenn Arcaro pleaded guilty to criminal charges for his participation in large-scale conspiracy involving BitConnect, a cryptocurrency investment scheme, which defrauded investors from the US and abroad of over $2 billion. Note also the related SEC action.
- National Cryptocurrency Enforcement Team (NCET) and Cyber-Fraud Initiative. On October 6, 2021, DOJ announced the establishment of the NCET and a new civil cyber-fraud initiative to assist with tracing and recovering assets lost to fraud and extortion
- May 2021 RFI. On May 17, 2021, the FDIC issued a request for information (RFI) seeking comment regarding current and potential future digital asset activities of banks. The RFI is intended to provide the FDIC with insight into the digital asset market and what role banks may play in it.
- Report on Regulation of Stablecoins. On November 1, 2021, the FDIC, in conjunction with the OCC and the President’s Working Group on Financial Markets, released a report on stablecoins providing recommendations on oversight. The report recommended that:
- regulatory agencies such as the SEC, CFPB, and CFTC exercise authority over stablecoin arrangements;
- Congress should act to bring stablecoin arrangements under federal oversight on a comprehensive basis that would regulate stablecoin issuers in the same way as insured depository institutions (IDIs) are regulated, and “urgently” pass legislation to regulate stablecoin issuers; and
- the Financial Stability Oversight Council (FSOC) should act to designate certain activities of these stablecoin arrangements as systemically important.
- Joint statement on prudential bank crypto regulation. On November 23, 2021, the Board of Governors of the Federal Reserve System, the FDIC and the OCC issued a joint statement on the development of policy initiatives related to crypto-asset activities in the US federal banking system. The joint statement was designed to provide a road map of areas of focus for the agencies going forward. The statement reflects public comment from the FDIC’s May 2021 RFI.
- First chief digital currency advisor appointed. On July 6, 2021, FinCEN announced appointment of its first-Ever Chief Digital Currency Advisor.
- BitMEX enforcement action. On August 10, 2021, FinCEN and the CFTC each announced settlement with offshore cryptocurrency derivatives trading platform BitMEX, settling charges BitMEX illegally operated a cryptocurrency trading platform that was accessed by US market participants, as well as related anti-money laundering (AML) violations. FinCEN found that US customers were able to access the BitMEX platform and conduct cryptocurrency derivatives trading without appropriate customer due diligence, and in certain cases, BitMEX senior leadership altered US customer information to hide the customer’s true location.
- Ransomware advisory. On November 8, 2021, FinCEN released an Advisory on Ransomware and the Use of the Financial System to Facilitate Ransom Payments, updating its 2020 advisory. This advisory sets out financial red-flag indicators of ransomware-related illicit activity to assist financial institutions, including VC service providers, in identifying and reporting suspicious activity. Also, on October 15, 20221, FinCEN issued a report on ransomware trends in BSA data.
- Interpretive Letter #1174 – node verification and stablecoin payments. On January 4, 2021, the OCC issued Interpretive Letter #1174, which clarified the authority of national banks and federal savings associations to participate in independent node verification networks (INVN) and use stablecoins to conduct payment activities and other bank-permissible functions. The letter is intended to remove any legal uncertainty about the authority of banks to connect to blockchains as validator nodes and thereby transact stablecoin payments on behalf of customers.
- OCC fintech/crypto national trust bank charters. On January 13, 2021, the OCC granted conditional approval for the conversion of Anchorage Trust Company, a South Dakota-chartered non-depository public trust company offering digital asset and cryptocurrency custody services, to become the first cryptocurrency trust company to operate under a national trust bank charter. The OCC has since granted two additional national trust bank charters: Paxos National Trust, which received preliminary conditional approval on April 23, 2021, and Protego Trust, granted approval on February 4, 2021.
- Report on regulation of stablecoins. On November 1, 2021, the OCC, in conjunction with the FDIC and the President’s Working Group (PWG) on Financial Markets, released a report on stablecoins providing recommendations on oversight (see Legal Update, President’s Working Group on Financial Markets Issues Report on Regulation of Stablecoins). The report recommended that:
- regulatory agencies such as the SEC, CFPB, and CFTC exercise authority over stablecoin arrangements;
- Congress should act to bring stablecoin arrangements under federal oversight on a comprehensive basis that would regulate stablecoin issuers in the same way as insured depository institutions (IDIs) are regulated, and “urgently” pass legislation to regulate stablecoin issuers; and
- the Financial Stability Oversight Council (FSOC) should act to designate certain activities of these stablecoin arrangements as systemically important.
- Joint statement on prudential bank crypto regulation. On November 23, 2021, the Board of Governors of the Federal Reserve System, the FDIC and the OCC issued a joint statement on the development of policy initiatives related to crypto-asset activities in the US federal banking system. The joint statement was designed to provide a road map of areas of focus for the agencies going forward.
- Interpretive Letter #1179 – affirmation of prior OCC crypto interpretive notices. On November 18, 2021, the OCC issued Interpretive Letter #1179, which clarifies that national banks and federal savings associations must demonstrate that they have adequate controls in place before they can engage in certain cryptocurrency, distributed ledger, and stablecoin activities, as specified in certain prior OCC interpretive letters #1170, #1172, and #1174 (see above) on the cryptocurrency activities of banks. Interpretive Letter #1179 also reiterates that under OCC Interpretive Letter #1176, the OCC retains discretion to determine, for purposes of federal law, whether an activity is a trust activity and whether an activity is conducted in a fiduciary capacity.
- BitPay enforcement action. On February 18, 2021, OFAC announced a settlement with Atlanta-based BitPay, Inc. for apparent violations of multiple OFAC sanction programs related to transactions in digital currency including enabling individuals in Crimea, Cuba, Iran, North Korea, Sudan, and Syria to use BitPay’s platform to access US merchants.
- SDN Listing of SUEX OTC and related parties. On September 21, 2021, OFAC announced the addition of Russian-based cryptocurrency exchange SUEX OTC, S.R.O. to OFAC’s Specially Designated Nationals (SDN) list for facilitating financial transactions of ransomware actors – the first such OFAC designation of a virtual currency exchange. On November 8, 2021, OFAC announced the addition of VC exchange Chatex and other affiliated network and ransomware operators related to SUEX to its SDN list for facilitating financial transactions of ransomware actors.
- Guidance and updated FAQs on virtual currency sanctions compliance. On October 15, 2021, OFAC issued new sanctions compliance guidance, which outlines best practices tailored to the unique risks posed in the VC industry. The FAQs define, for purposes of OFAC sanctions programs, what is meant by the terms “digital currency,” “digital currency wallet,” “digital currency address,” and “virtual currency.” For purposes of OFAC sanctions:
- digital currency includes sovereign cryptocurrency, virtual currency (non-fiat), and a digital representation of fiat currency.
- VC is neither issued nor guaranteed by any jurisdiction and is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.
- SEC 2021 actions against digital asset platforms and exchanges. The SEC has taken enforcement action against a number of digital asset exchanges and platforms, including the following:
- Coinbase – September 7, 2021.
- BitConnect – September 1, 2021; May 28, 2021
- Poloniex – August 9, 2021
- Blockchain Credit Partners d/b/a DMM (DeFi Money Market) – August 6, 2021
- Coinschedule – July 19, 2021. Note statement from commissioners Peirce and Roisman regarding failure of SEC to determine which offered coins were securities.
- Coinseed – February 17, 2021
- First bitcoin ETF. On October 19, 2021, ProShares Advisors LLC began offering ProShares Bitcoin Strategy exchange-traded fund (ETF) – the first bitcoin ETF – which provides investors with exposure to bitcoin futures contracts. The SEC did not raise an objection to the launch within the required 75-day review period.
Different digital tokens have different purposes. The regulations that are applicable to particular cryptocurrency collateral must be determined on a case by case basis. For instance, all the major US banking regulators have, to some degree or another, taken the position that their existing regulatory authority permits them to regulate cryptocurrencies.
As far back as March 2013 the Financial Crimes Enforcement Network (FinCEN) issued guidance concluding that an:
”administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations.”
However, mere use of cryptocurrencies by a user to “purchase real or virtual goods or services” does not fit within the definition of “money transmission services” under FinCEN regulations. This designation means that exchangers and administrators of cryptocurrencies qualify as money service businesses (MSB) under the Bank Secrecy Act (BSA). Covered entities must comply with AML and KYC regulations, including those that require the monitoring and reporting of suspicious transactions.
FinCEN noted in the guidance that “accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA.” The guidance requires people in the business of exchanging cryptocurrencies for traditional or other type of currency to register with FinCEN and follow other anti-money laundering measures.
The Securities and Exchange Commission (SEC) has taken the position that certain digital tokens, including those that are essentially digital representations of traditional equity or debt interests, are plainly securities under the Securities Act. These include digital tokens representing things, such as partnership interests or bonds. For other tokens, the characterization as securities is less clear. An analysis is therefore needed on a case by case basis.
A digital token may be considered to be a security if the participants in the offering made an investment of money in a common enterprise with a reasonable expectation of profits that are derived from the entrepreneurial and managerial efforts of others. The SEC relies on the test developed in SEC v. W.J. Howey & Co. in making this determination. If the digital token is a security, several obligations are triggered under US securities laws, including the need to either register the offering of these securities with the SEC (unless an exemption is available).
For instance, if the token is transmitted to purchasers on behalf of issuers or sellers, the party transmitting the token may be considered a “broker-dealer” for the purposes of the Securities Exchange Act of 1934 and that party may be required to register as a broker-dealer.
Since 2014, the Commodities Futures Trading Commission (CFTC) has taken the position that cryptocurrencies may constitute “commodities” under the Commodity Exchange Act and thus be subject to CFTC jurisdiction. As a consequence, the CFTC alleges that it has broad jurisdiction over derivatives that reference cryptocurrencies and market participants that are involved in those contracts. The CFTC has also asserted its authority to pursue allegations of fraud or manipulation regarding the cryptocurrency itself.
In addition to the above US federal agencies, US state laws may apply to transactions involving cryptocurrencies. Non-US laws may apply as well.
A lender that decides to take a security interest in cryptocurrency assets should perform an analysis of all regulatory regimes that may be applicable to the particular assets in question.
Sources: (1) Cryptocurrency Regulatory Tracker – Practical Law USA
(2) https://koinly.io/cryptocurrency-taxes/ Accessed 15 Feb. 2022
Common Forms of Fund Investments in Cryptocurrency
- Portfolios of cyptocurrency: BTC, ETH, XRP, SOL, DOT, etc.
- Classified as convertible virtual currency
- NFTs or Non-Fungible Tokens
- Most likely, also classified as convertible virtual currency
- Borrowing, lending, earning rewards
- “Market neutral” strategies and high frequency trading
- SAFTs, SAFTEs, Token Warrants
- Cryptocurrency derivative instruments
- Notice 2014-21 and IRS FAQs establish basic rule for convertible virtual currency (property transactions):
- Convertible virtual currency is treated as regular intangible personal property; foreign currency rules of §985 et seq. do not apply
- Mining rewards are ordinary income
- General employment, self-employment tax rules apply
- General character rules apply (e.g., ordinary income if dealer, as miners often likely to be)
- Basis recovery on sales: FIFO default, else specific identification
- Tokens for services (including “micro-tasks”) taxable as normal
- CCA 20203511
- Like-kind claims on token-for-token exchange do not work post-TCJA, and pre-TCJA very difficult to argue
- CCA 202114020
- “Air dropped” tokens or new tokens received on division of network into two networks are taxable at such time token recipient has dominion and control over new tokens
- Rev. Rul. 2019-24; CCA 202124008
- Reporting: Generally, same reporting rules as other property (so if crypto tokens paid as wages, should be on W-2, etc.); recent addition of §6045(c)(1)(D) and §6050I(d)(3) (discussed later)
How Far Does Guidance Go?
- No two networks alike: Analyze rights associated with token and network at issue; often distinguishable from Bitcoin, so much so that Notice 2014-21 might not be on point
- Not uncommon to argue “wrapping” and “bridging” transactions are not realization events
- Is “crypto form” associated with any common treatment?
- What is a network, and who owns it?: Guidance fails to answer who you are transacting with when you are transacting with “the network”, and to whom network activities might be attributed
- Consider whether your tax theory implies existence of entities, what their classification is (consider §7704), or if there is a violation of anti-“homeless income” rule of §468B(g)
- Special treatment?: Some participants stretch guidance, perhaps too far
- E.g., “dominion and control” concept in airdrop guidance used as argument for deferral that seems to not accord with general tax accounting rules
- But airdrop rules themselves do not accord with, e.g., unsolicited merchandise authorities
- Tax-exempt and foreign investors: No direct guidance offered on UBTI, ECI, sourcing, and withholding matters
- Mining can be trade or business
CRYPTO TAX – GENERAL RULES
- Sale of Convertible Virtual Currency (CVC) – e.g. BTC, ETH
- Famously (or some would say, infamously) in 2014, the IRS issued Notice 2014-21 which concluded that virtual currency is treated as property not currency
- Thus, a sale of cryptocurrency or using crypto to pay for goods/services will be subject to gain recognition just like a sale of any other asset (i.e. if a coin was acquired for $1,000 and used to pay for goods or services valued at $1,500, the owner would need to recognize gain of $500 when using the coin, character of gain to be discussed later)
- This may or may not necessarily apply to non-fungible tokens (no such pronouncements from the IRS on NFTs)
- Receiving Cryptocurrency
- Receiving crypto as payment for providing a service
- Mining crypto and earning rewards
- Staking crypto and earning rewards
- Lending crypto and receiving interest payments
- May be ordinary income taxed at FMV (in USD) on date received
- Transfers between wallets of the same taxpayer are not taxable
- Exchange of CVC
- Exchange of one type of cryptocurrency for another is NOT eligible for Section 1031 treatment
- Also includes exchanging CVC for stablecoin
- Exchange of one type of cryptocurrency for another is NOT eligible for Section 1031 treatment
- Each trade of one cryptocurrency for another is a taxable event, the user must keep track of how much is gained or lost (in USD) on each transaction
- Ordering rules
- Since virtual currency is considered property and not a type of currency, it is not fungible. Therefore, a user can specifically identify which coin is being sold or exchanged in order to benefit from long- term capital gains rates
- This would apply regardless of whether the coins or held in a single wallet or as is more likely, across multiple wallets
- However, easier to identify if in single wallet
- If not specifically identified, FIFO likely to be utilized
CRYPTO TAX – IMPACT ON INVESTORS
- Different investor classes have different concerns and interests
- US taxable investor
- Subject to graduated rates on ordinary income
- Avoid two levels of taxation (flow-through treatment on investment vehicle)
- Maximize long-term capital gains
- Defer recognition
- US tax-exempt investor
- Tax exempt income only
- Avoid UBTI
- »Are mining activities, staking activities and staking rewards treated as UBTI? Some have argued no different than a dividend but there are differences
- »May depend upon amount of computing power utilized
- »Funds can use AIVs (alternative investment vehicles) or blockers to get around potential UBTI issues
- Absent further guidance, this will remain a hot-button issue
- Non-US investor
- In general, foreign investors are exempt from US tax on capital gains and therefore have a strong preference that income generated from investments in crypto be treated as not related to a US trade or business
- Investment activities vs. trading activities
- Commodity trading safe harbor under 864(b)
- » Mining plus selling = dealer in cryptocurrencies?
- AIVs/Blocker structures could be utilized
- Although not without some uncertainty, it would appear income generated would not be FDAP
- US taxable investor
Timing and Tax Accounting for Airdrops, Hard Forks
- When should taxpayers include airdrops, hard forks and staking rewards in income?
- Under Rev. Rul. 2019-24, new cryptocurrency received in an airdrop or hard fork is taxable at the time the taxpayer asserts “dominion and control” over the cryptocurrency.
- What do we know?
- The treatment of cryptocurrency account holders on exchanges such as Coinbase.
- When the holder maintains an account on a cryptocurrency exchange, the holder is taxed when the new cryptocurrency is credited to the holder’s account. For example, BCH split from BTC in a hard fork on August 1, 2017. But Coinbase only credited BTC accountholders with BCH on December 19, 2017. Under Rev. Rul. 2019-24, the Coinbase accountholders are only taxed on BCH on Dec. 19, 2017, not on Aug. 1, 2017.
Timing and Tax Accounting for Airdrops, Hard Forks: Private Keys and Dominion and Control
- What is unclear about timing for Airdrops, Hard Forks and staking? The significance of control over a private key.
- What if the holder has sole control over the private key? In CCA 202114020, this meant taxpayer had income at the precise moment of the BCH split.
- When a taxpayer receives an unsolicited airdrop, such as BCH, and the taxpayer controls her private key, is the appearance of an unspent transaction in the form of BCH on a blockchain ledger sufficient to trigger a taxable event? Or does the taxpayer have to assert some more clear indication of dominion and control?
- On the date of exercising “dominion and control” over an airdrop or hard fork, the taxpayer has ordinary income equal to the value of the airdrop or hard fork and the taxpayer’s holding period begins.
- Taxpayers arguably have flexibility to document the beginning or deferral of income from an airdrop especially if this documentation is contemporaneous, uniformly applied, has some independent justification and is not purely backwards cherry picking.
- For example, for deferring during a diligence period, the taxpayer may explain a process for identifying an airdrop / hard fork and determining if an airdrop is safe to control.
- For accelerating the inclusion of the airdrop / hard fork, the taxpayer may document intent to assert control on a specific date.
Timing and Tax Accounting for Staking
- For staking income, similar issues arise in the context of timing.
- With other staking rewards, stakers can be penalized or have to pay a fee to receive their rewards.
- The rewards can be identified with a particular wallet address but claiming the rewards requires the wallet holder to incur some expense.
- Here, is it proper to defer income until stakers pay the fee and assert control over the rewards? Does the period of deferral matter?
- In Jarrett, the taxpayers are arguing that staking rewards are only taxable when the rewards are sold. Here, the taxpayers claim staking rewards are self-created property. They are not claiming timing is based on dominion and control. [This will be covered later.]
Timing and Tax Accounting for Tokens Subject to Lock Up
- Sometimes, taxpayers receive airdrops or grants of cryptocurrency subject to trading restrictions.
- For example, an advisor to a project receives a grant of a new cryptocurrency token subject to a one-year lockup period.
- What is the significance of lockups and restrictions on trading?
- Does it matter if the lockup is enforced through a contract specifying the time when the holder has the legal right to trade or transfer the cryptocurrency?
- What is the trading restriction is enforced through software coding and a “smart contract” but not through a legally enforceable contract?
- The holder’s method of accounting matters: cash vs. accrual.
- Cash basis taxpayers are taxed on actual or constructive receipt of cryptocurrency.
- Under United States v. Fletcher 562 F.3d 839 (7th Cir. 2009), in deciding if stock placed in escrow subject to a lockup period was constructive received, the Seventh Circuit explained that to determine if constructive receipt takes place, “The more likely it is that the conditions will be satisfied, and all restrictions lifted, the more sensible it is to treat all of the stock as constructively received when deposited in the account.”
- For cryptocurrency subject to a lockup, the timing of taxation depends on how likely it is that all conditions will be satisfied and the cryptocurrency released from the lockup.
- The cryptocurrency could be subject to loss through hacking, network disruptions, lose of private keys, an absence of a market to trade or exchange.
Taxation of New Tokens and Token Projects: SAFT (Simple Agreement for Future Tokens) Framework
- In October 2017, Cooley and Protocol Labs published SAFT whitepaper, purporting to identify a way to issue tokens in compliance with securities law.
- A SAFT contract is a security, but the token issued pursuant to a SAFT was supposed to be a functional consumer good that was not a security.
- SAFT framework no longer appears to be viable as originally envisioned because the SEC has not created any safe harbor or framework for issuing tokens that are not securities.
- However, investors continue to be interested in tokens and SAFTs and similar contracts continue to be used.
Simple Agreement for Future Tokens or Equity (SAFTE) and other convertibles
- No clear replacement for SAFT, but many variations have sprung up: token warrants, DPA (debt payable by assets), SAFTE, others.
- Investors want option for equity in the event there is an early equity fundraising round before a token sale or if tokens can’t be publicly issued.
- SAFT had advantage of simplicity and was based on model that VC investors are familiar with. Convertible contracts are more complex and raise tax issues.
Tax Considerations for SAFT: Token Issuer
- SAFT is generally treated as a prepaid forward contract for tax purposes.
- In a SAFT, the token issuer typically has to return all money if the token is not issued by a specific date in the future. How important is this feature / requirement in a SAFT contract?
- Token issuer is not taxable on SAFT proceeds until token is issued.
- When token is issued, issuer has taxable revenue equal to original SAFT proceeds, but may deduct all expenses up to (and including) the year of issuing the token.
- Assuming tax event is deferred until token is issued, no “phantom income” and tax is deferred until token is issued!
- Is it proper for issuer to defer income until token is issued?
Tax Considerations for SAFT: Investor
- BECAUSE SAFT IS TREATED AS PREPAID FORWARD CONTRACT, THE SAFT IS TREATED AS A CONTRACT SEPARATE FROM THE TOKENS.
- FOR INVESTOR, SAFT IS PROPERTY, BUT NOT THE SAME AS TOKEN.
- INVESTOR STARTS HOLDING PERIOD IN TOKEN THE DAY AFTER TOKEN IS ISSUED.
Tax Considerations for SAFTE, convertible contracts
- SAFTE and other contracts that are convertible into equity or tokens are likely treated as equity for tax purposes from day one, not a forward contract.
- If investor converts into tokens, there may be adverse tax consequences if the token has a high value.
- First, the company has “phantom income” equal to the market value of the token (based on price on exchange on date of conversion).
- Second, the investor has gain or loss equal to the difference between the market value of the token and the investor’s original investment.
Self-Creation, Extraction for Rewards
- Argument: Operators create/discover/extract tokens when they receive reward—”Who else could it be?”
- Jarrett settlement is weak support
- Tax Treatment if Right: No tax on receipt, ordinary income on sale (as almost certain inventory); partnership structures a la natural resources could aid planning
- Problems: Not widely viewed as correct by practitioners
- Analogy: Equity compensation from companies can equally be drafted as “appearing” in hands of compensee, but clearly “from” service recipient (company)
- Distinction #1: Rewards economically exist to incentivize operators to do service to network (updating, validating) and therefore its users; self-creation and extraction do not benefit others until they receive ownership of product
- Distinction #2: Crypto market extraordinarily liquid; arguably closer to receiving cash than most commodities—it’s why convertible virtual currencies distinguished from non-convertible
Inflationary Treatment of Rewards
- Argument: Varies, but centers on economics—issuance of new rewards from network for staking/mining is inflationary, and thus would apparently devalue existing tokens—miners/stakers should not be taxed on rewards to the extent they reduce value of holdings
- Tax Treatment if Right: Some portion of tokens received by miner/staker either received free of tax, or miner/staker receives deduction (potentially subject to deduction limitations)
- Theories: Not widely viewed as correct by practitioners
- Analogy to stock dividends seems misplaced; Eisner v. Macomber, 252 U.S. 189 (1920) de facto not good law, and current §305 has “hair trigger” rules easily causing 99% stock dividend to be wholly taxable
- Hyperinflationary currency rules not applicable (not a currency, El Salvador’s recognition not a clear change because of lack of government control)
- Arguably a supplier-based intangible (right to receive network services from network operators), but no useful life limit or obvious basis to depreciate
- If tokens represent undivided interest in total network benefits, could argue new token issuance creates deduction to previous owners; with specific identification, perhaps could choose high-basis tokens
Trade or Business? Whose?
- Does automation matter?
- View #1: Nothing about automated nature of mining/staking appears to prevent trade or business finding; a store run by robots seems to still be a store, if avoids indicia of hobby, has sufficient regularity to rise to that level
- View #2: For staking at least, or perhaps just delegation, activity is minor; no specialized equipment needed—merely having to ask for dividends to receive them is not a business, and this seems like not that much more
- Other question is delegator’s role in staking trade or business
- They are paid a percentage of what network operator receives, per token staked
- Not clear this is net profits as typically needed to find partnership—perhaps merely gross receipts
- Also not clear delegated tokens are “used” by network operator as capital
- Closely resembles a guarantor/surety, with delegation effectively a form of risk underwriting for operator, except with payment done as percentage of gross receipts and amount of underwriting
Use of Blocker Corporations to Solve Differing Investor Tax Preferences
- Goals of Blocker Corporation
- Locate UBTI/ECI-generating activity below corporation, and corporation reports instead of investors
- Generally, only foreign/tax-exempts will want to be in blocker (usually just adds to U.S. taxable’s tax)
- Jurisdiction of Blocker
- For income avoiding U.S. ECI or withholding tax, foreign is better; no tax at foreign corp level nor to tax-exempt or foreign taxable holders
- Else, foreign may create greater total taxation
- Other Tax Savings with Blocker?
- Debt-financing can sometimes be used to reduce effective tax rate (because interest may avoid U.S. tax)
- U.S. taxable persons can benefit from investing through foreign corporation in special circumstances (e.g., CFC/PFIC can avoid deduction limitations; non-CFC non-PFIC can create long-term income deferral)
Notes: Blocker “above” structure pictured, but blocker “below” also possible. Sponsor entities not pictured
Considerations for Three Investor Types
– Consider self-creation, extraction, inflationary positions; perhaps better left to investors to take contrary position
– Delegation might avoid UBTI; assume otherwise not avoided
– Assume onshore mining/staking creates ECI; perhaps delegation is exception
– If delegation is exception, sourcing appears to be location of business of network operator (analogy to guarantee fees); operator presumably failing to withhold
Especially for tax-exempt, foreign, consider mining/staking in foreign corp with operations fully offshore
– Even U.S. could benefit if offshore income merely GILTI or corporation avoids CFC, PFIC status
CRYPTO TAX – CLASSIFICATION – OTHER PURPOSES
– 704(c) and Treas. Reg. 1.704-3(a)(10) –”Anti-abuse rule”
o “Allocation method is not reasonable if the contribution of property and the corresponding allocation of tax items with respect to the property are made “with a view” to shifting the tax consequences of built-in gain or loss among the partners in a manner that substantially reduces the present value of the partners’ aggregate tax liability”
– FAA 20204201F noted: “Sec 704(c) regulations do not describe what is required for a contribution of property and allocation of tax items to be made “with a view” to shift the tax consequences with respect to the property
– How would a contribution of cryptocurrency be impacted by these rules?
What if my Crypto is Stolen, Lost, or becomes Worthless?
- Section 165(a) permits noncorporate taxpayers to deduct certain losses connected to a trade or business or in a transaction entered into for profit.
- This may allow individuals to claim deductions for lost or stolen cryptoassets may include when accounts or wallets are hacked, exchanges disappear, private keys are stolen, or if the hardware or software that stores private keys is destroyed.
- Because BTC is likely a commodity, not a “security” the consensus among tax practitioners is that it does not qualify for a worthless security loss under §165(g).
- The character of any such loss is a complex topic and could potentially be capital or ordinary depending on the specific facts, and especially whether the taxpayer received any consideration or benefit from the loss.
- Cryptocurrency transactions could result in reportable loss transactions subject to disclosure on Form 8886 if a taxpayer claims a loss under §165 in excess of certain thresholds.
Will my contributions of Crypto to a Partnership be Tax Free?
- Under Code §721(a) Contributions of property (like crypto) to entities treated as partnerships are normally tax free.
- But, under Code §721(b), a contributor will have to recognize gain (not loss) if:
- The partnership is an “Investment Company.”
- Such contribution results in a diversification of the transferor’s interests.
Definition of “Investment Company”
- For purposes of §721(b) “Investment company” means an entity with a value consisting of 80% or more of “stock and securities.”
- “Stocks and securities” are defined in §351(e)(1)(B) as:
- – Money/ foreign currency
- – Stock and other equity interests in a corporation, loans and debt, options, forward or futures contracts, notional principal contracts (such as swaps), and derivatives
- – Equity interests or convertible interests in a partnership, REIT, mutual fund or other related entities
- – Any interest in a precious metal unless used or held in the active conduct of a trade or business after the contribution
- – An interest in an entity that consists of any of the above.
- Contributors of crypto must ask two questions:
- – Is the contributed cryptocurrency classified as “stocks and securities”?
- As we will discuss later, there is a general consensus among tax practitioners is that most crypto, including BTC, are commodities, not “stocks and securities.”
- – If the contributed crypto is classified as “stock and securities” does the total value of the partnership consist of 80% “stock and securities” as defined above?
Most Cryptocurrencies are not classified as “stocks and securities”
- Most cryptocurrencies are not “stocks and securities” but are likely “commodities” and therefore may be exempt from the “diversification” rule.
- To the extent a cryptocurrency may be classified as stock or a security, the contribution of such cryptocurrency is potentially taxable to the extent the fund is an “investment company” and the contribution results in diversification.
Distributions of Crypto from a Partnership
- When a partnership makes a distribution to a partner, §731(a)(1) provides that gain is not recognized by the partner except for “money” distributed that exceeds the adjusted basis of the partner’s interest in the partnership immediately before the distribution.
- §731(c) treats “marketable securities” distributed by a partnership as a distribution of “money” for purposes
- of determining gain under §731(a).
- – Generally, “marketable securities” for purposes of §731(c) are financial instruments and foreign currencies that are actively traded (as defines in §1092(d)(1)) on the date of distribution.
- ”Marketable securities” treatment will not generally apply in two circumstances:
- – The partner had previously contributed the security to the partnership
- – An investment partnership makes the distribution to an eligible partner under §731(c)(3)(C)(iii)(I) who only contributed qualified assets defined in 731(c)(3)(C)(i)
- Although the IRS has not issued any guidance on the matter, BTC (and many other cryptocurrencies) is
- likely classified as a commodity, not a “marketable security”.
Distributions of Crypto from a Partnership: Loss
- A partner will not recognize loss on a partnership distribution unless all three of the following requirements are met:
- – The adjusted basis of the partner’s interest in the partnership exceeds the distribution.
- – The partner’s entire interest in the partnership is liquidated.
- – The distribution is in money, unrealized receivables, or inventory items.
Wash Sale (§1091)
- If applicable, could defer losses if sale of built-in-loss crypto and purchase of (or entering into olf contract or option to acquire) substantially identical crypto made within 30 days of one another
Only applicable if crypto is “stock or securities”; very unlikely for most crypto, considering narrow read of that under §1091
- – See Gantner v. Commissioner, 91 T.C. 713 (1988)
- Failed effort to amend §1091 to apply to digital assets further evidence it does not currently apply
Straddles (§263(g) and §1092)
- If applicable, loss and interest to carry offsetting position deferred until position and offsetting position both closed; holding period may also restart
- Can apply to cryptocurrencies, as many are likely traded on “interdealer market” or otherwise on an established market, and thus can be publicly traded personal property
- Does require substantially offsetting positions, potentially including certain derivatives, options, or loans of crypto
CRYPTO TAX – REPORTING
Crypto tax reporting for individuals
- Ordinary income included on the 1040 or Schedule 1 as applicable
- Capital gains and losses reported on Form 8949 (like other capital assets)
- Question is front and center on the 1040:
- IRS has announced increased efforts to investigate and refer individuals that are engaging in criminal tax fraud concerning cryptocurrencies for prosecution
- IRS is keen on investigating those who are falsely reporting their virtual currency income or those who are intentionally failing to report their income from virtual currency transactions
Crypto tax reporting for Brokers
- New IRC Section 6045A(d) (effective for returns required to be filed, and statements required to be furnished, after 12/31/2023)
- Any broker, regarding any transfer (which is not part of a sale or exchange executed by the broker) during a calendar year of a covered security which is a digital asset from an account maintained by the broker to an account which is not maintained by, or an address not associated with, a person that the broker knows or has reason to know is also a broker, will be required to make a return for that calendar year, in the form determined by IRS
Crypto tax reporting for ANY trade or business
- o Section 6050I has been amended to require a business that receives
- $10,000 in digital assets to file Form 8300 within 15 days of the receipt
- of the digital asset
- o Similar to new reporting for brokers, this is effective for transactions after 1/1/24
- o Thus, if, on January 2, 2024, a seller receives as payment $6,000 cash and $6,000 in Bitcoin, the seller will need to file Form 8300 by January 17, 2024
Crypto tax reporting for all taxpayers
- Form 14457 updated to include voluntary disclosure for crypto related matters
- The form allows you to add additional rows to report all different types of virtual currency
Frequently Asked Questions
Q1. What is virtual currency?
A1. Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency. The IRS uses the term “virtual currency” in these FAQs to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.
Q2. How is virtual currency treated for Federal income tax purposes?
A2. Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. For more information on the tax treatment of virtual currency, see Notice 2014-21. For more information on the tax treatment of property transactions, see Publication 544, Sales and Other Dispositions of Assets.
Q3. What is cryptocurrency?
A3. Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A transaction involving cryptocurrency that is recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction.
Q4. Will I recognize a gain or loss when I sell my virtual currency for real currency?
A4. Yes. When you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses. For more information on capital assets, capital gains, and capital losses, see Publication 544, Sales and Other Dispositions of Assets.
Q5. The 2020 Form 1040 asks whether at any time during 2020, I received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency. During 2020, I purchased virtual currency with real currency and had no other virtual currency transactions during the year. Must I answer yes to the Form 1040 question? (updated March 2, 2021)
A5. No. If your only transactions involving virtual currency during 2020 were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question.
Q5(a). The 2021 Form 1040 asks whether at any time during 2021, I received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. During 2021, I purchased virtual currency with real currency and had no other virtual currency transactions during the year. How do I answer the question on the Form 1040? (added March 10, 2022)
A5(a). If your only transactions involving virtual currency during 2021 were purchases of virtual currency with real currency, you are not required to answer “yes” to the Form 1040 question, and should, instead, check the “no” box.
Q6. How do I determine if my gain or loss is a short-term or long-term capital gain or loss?
A6. If you held the virtual currency for one year or less before selling or exchanging the virtual currency, then you will have a short-term capital gain or loss. If you held the virtual currency for more than one year before selling or exchanging it, then you will have a long-term capital gain or loss. The period during which you held the virtual currency (known as the “holding period”) begins on the day after you acquired the virtual currency and ends on the day you sell or exchange the virtual currency. For more information on short-term and long-term capital gains and losses, see Publication 544, Sales and Other Dispositions of Assets.
Q7. How do I calculate my gain or loss when I sell virtual currency for real currency?
A7. Your gain or loss will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, which you should report on your Federal income tax return in U.S. dollars. For more information on gain or loss from sales or exchanges, see Publication 544, Sales and Other Dispositions of Assets.
Q8. How do I determine my basis in virtual currency I purchased with real currency?
A8. Your basis (also known as your “cost basis”) is the amount you spent to acquire the virtual currency, including fees, commissions and other acquisition costs in U.S. dollars. Your adjusted basis is your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars. For more information on basis, see Publication 551, Basis of Assets.
Q9. Do I have income if I provide someone with a service and that person pays me with virtual currency?
A9. Yes. When you receive property, including virtual currency, in exchange for performing services, whether or not you perform the services as an employee, you recognize ordinary income. For more information on compensation for services, see Publication 525, Taxable and Nontaxable Income.
Q10. Does virtual currency received by an independent contractor for performing services constitute self-employment income?
A10. Yes. Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
Q11. Does virtual currency paid by an employer as remuneration for services constitute wages for employment tax purposes?
A11. Yes. Generally, the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. Consequently, the fair market value of virtual currency paid as wages, measured in U.S. dollars at the date of receipt, is subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement. See Publication 15 (Circular E), Employer’s Tax Guide PDF, for information on the withholding, depositing, reporting, and paying of employment taxes.
Q12. How do I calculate my income if I provide a service and receive payment in virtual currency?
A12. The amount of income you must recognize is the fair market value of the virtual currency, in U.S. dollars, when received. In an on-chain transaction you receive the virtual currency on the date and at the time the transaction is recorded on the distributed ledger.
Q13. How do I determine my basis in virtual currency I receive for services I’ve provided?
A13. If, as part of an arm’s length transaction, you provided someone with services and received virtual currency in exchange, your basis in that virtual currency is the fair market value of the virtual currency, in U.S. dollars, when the virtual currency is received. For more information on basis, see Publication 551, Basis of Assets.
Q14. Will I recognize a gain or loss if I pay someone with virtual currency for providing me with a service?
A14. Yes. If you pay for a service using virtual currency that you hold as a capital asset, then you have exchanged a capital asset for that service and will have a capital gain or loss. For more information on capital gains and capital losses, see Publication 544, Sales and Other Dispositions of Assets.
Q15. How do I calculate my gain or loss when I pay for services using virtual currency?
A15. Your gain or loss is the difference between the fair market value of the services you received and your adjusted basis in the virtual currency exchanged. For more information on gain or loss from sales or exchanges, see Publication 544, Sales and Other Dispositions of Assets.
Q16. Will I recognize a gain or loss if I exchange my virtual currency for other property?
A16. Yes. If you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss. For more information on capital gains and capital losses, see Publication 544, Sales and Other Dispositions of Assets.
Q17. How do I calculate my gain or loss when I exchange my virtual currency for other property?
A17. Your gain or loss is the difference between the fair market value of the property you received and your adjusted basis in the virtual currency exchanged. For more information on gain or loss from sales or exchanges, see Publication 544, Sales and Other Dispositions of Assets.
Q18. How do I determine my basis in property I’ve received in exchange for virtual currency?
A18. If, as part of an arm’s length transaction, you transferred virtual currency to someone and received other property in exchange, your basis in that property is its fair market value at the time of the exchange. For more information on basis, see Publication 551, Basis of Assets.
Q19. Will I recognize a gain or loss if I sell or exchange property (other than U.S. dollars) for virtual currency?
A19. Yes. If you transfer property held as a capital asset in exchange for virtual currency, you will recognize a capital gain or loss. If you transfer property that is not a capital asset in exchange for virtual currency, you will recognize an ordinary gain or loss. For more information on gains and losses, see Publication 544, Sales and Other Dispositions of Assets.
Q20. How do I calculate my gain or loss when I exchange property for virtual currency?
A20. Your gain or loss is the difference between the fair market value of the virtual currency when received (in general, when the transaction is recorded on the distributed ledger) and your adjusted basis in the property exchanged. For more information on gain or loss from sales or exchanges, see Publication 544, Sales and Other Dispositions of Assets.
Q21. How do I determine my basis in virtual currency that I have received in exchange for property?
A21. If, as part of an arm’s length transaction, you transferred property to someone and received virtual currency in exchange, your basis in that virtual currency is the fair market value of the virtual currency, in U.S. dollars, when the virtual currency is received. For more information on basis, see Publication 551, Basis of Assets.
Q22. One of my cryptocurrencies went through a hard fork but I did not receive any new cryptocurrency. Do I have income?
A22. A hard fork occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income.
Q23. One of my cryptocurrencies went through a hard fork followed by an airdrop and I received new cryptocurrency. Do I have income?
A23. If a hard fork is followed by an airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive that cryptocurrency.
Q24. How do I calculate my income from cryptocurrency I received following a hard fork?
A24. When you receive cryptocurrency from an airdrop following a hard fork, you will have ordinary income equal to the fair market value of the new cryptocurrency when it is received, which is when the transaction is recorded on the distributed ledger, provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.
Q25. How do I determine my basis in cryptocurrency I received following a hard fork?
A25. If you receive cryptocurrency from an airdrop following a hard fork, your basis in that cryptocurrency is equal to the amount you included in income on your Federal income tax return. The amount included in income is the fair market value of the cryptocurrency when you received it. You have received the cryptocurrency when you can transfer, sell, exchange, or otherwise dispose of it, which is generally the date and time the airdrop is recorded on the distributed ledger. See Rev. Rul. 2019-24 PDF. For more information on basis, see Publication 551, Basis of Assets.
Q26. I received cryptocurrency through a platform for trading cryptocurrency; that is, through a cryptocurrency exchange. How do I determine the cryptocurrency’s fair market value at the time of receipt?
A26. If you receive cryptocurrency in a transaction facilitated by a cryptocurrency exchange, the value of the cryptocurrency is the amount that is recorded by the cryptocurrency exchange for that transaction in U.S. dollars. If the transaction is facilitated by a centralized or decentralized cryptocurrency exchange but is not recorded on a distributed ledger or is otherwise an off-chain transaction, then the fair market value is the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an on-chain transaction.
Q27. I received cryptocurrency in a peer-to-peer transaction or some other type of transaction that did not involve a cryptocurrency exchange. How do I determine the cryptocurrency’s fair market value at the time of receipt?
A27. If you receive cryptocurrency in a peer-to-peer transaction or some other transaction not facilitated by a cryptocurrency exchange, the fair market value of the cryptocurrency is determined as of the date and time the transaction is recorded on the distributed ledger, or would have been recorded on the ledger if it had been an on-chain transaction. The IRS will accept as evidence of fair market value the value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time. If you do not use an explorer value, you must establish that the value you used is an accurate representation of the cryptocurrency’s fair market value.
Q28. I received cryptocurrency that does not have a published value in exchange for property or services. How do I determine the cryptocurrency’s fair market value?
A28. When you receive cryptocurrency in exchange for property or services, and that cryptocurrency is not traded on any cryptocurrency exchange and does not have a published value, then the fair market value of the cryptocurrency received is equal to the fair market value of the property or services exchanged for the cryptocurrency when the transaction occurs.
Q29. When does my holding period start for cryptocurrency I receive?
A29. Your holding period begins the day after it is received. For more information on holding periods, see Publication 544, Sales and Other Dispositions of Assets.
Q30. Do I have income when a soft fork of cryptocurrency I own occurs?
A30. No. A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency. Because soft forks do not result in you receiving new cryptocurrency, you will be in the same position you were in prior to the soft fork, meaning that the soft fork will not result in any income to you.
Q31. I received virtual currency as a bona fide gift. Do I have income?
A31. No. If you receive virtual currency as a bona fide gift, you will not recognize income until you sell, exchange, or otherwise dispose of that virtual currency. For more information about gifts, see Publication 559, Survivors, Executors, and Administrators.
Q32. How do I determine my basis in virtual currency that I received as a bona fide gift?
A32. Your basis in virtual currency received as a bona fide gift differs depending on whether you will have a gain or a loss when you sell or dispose of it. For purposes of determining whether you have a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift. For purposes of determining whether you have a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift. If you do not have any documentation to substantiate the donor’s basis, then your basis is zero. For more information on basis of property received as a gift, see Publication 551, Basis of Assets.
Q33. What is my holding period for virtual currency that I received as a gift?
A33. Your holding period in virtual currency received as a gift includes the time that the virtual currency was held by the person from whom you received the gift. However, if you do not have documentation substantiating that person’s holding period, then your holding period begins the day after you receive the gift. For more information on holding periods, see Publication 544, Sales and Other Dispositions of Assets.
Q34. If I donate virtual currency to a charity, will I have to recognize income, gain, or loss?
A34. If you donate virtual currency to a charitable organization described in Internal Revenue Code Section 170(c), you will not recognize income, gain, or loss from the donation. For more information on charitable contributions, see Publication 526, Charitable Contributions.
Q35. How do I calculate my charitable contribution deduction when I donate virtual currency?
A35. Your charitable contribution deduction is generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year. If you have held the virtual currency for one year or less at the time of the donation, your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution. For more information on charitable contribution deductions, see Publication 526, Charitable Contributions.
Q36. When my charitable organization accepts virtual currency donations, what are my donor acknowledgment responsibilities? (added December 26, 2019)
A36.A charitable organization can assist a donor by providing the contemporaneous written acknowledgment that the donor must obtain if claiming a deduction of $250 or more for the virtual currency donation. See Publication 1771, Charitable Contributions Substantiation and Disclosure Requirements PDF, for more information.
A charitable organization is generally required to sign the donor’s Form 8283, Noncash Charitable Contributions, acknowledging receipt of charitable deduction property if the donor is claiming a deduction of more than $5,000 and if the donor presents the Form 8283 to the organization for signature to substantiate the tax deduction. The signature of the donee on Form 8283 does not represent concurrence in the appraised value of the contributed property. The signature represents acknowledgement of receipt of the property described in Form 8283 on the date specified and that the donee understands the information reporting requirements imposed by section 6050L on dispositions of the donated property (see discussion of Form 8282 in FAQ 36). See Form 8283 instructions for more information.
Q37. When my charitable organization accepts virtual currency donations, what are my IRS reporting requirements? (added December 26, 2019)
A37. charitable organization that receives virtual currency should treat the donation as a noncash contribution. See Publication 526, Charitable Contributions, for more information. Tax-exempt charity responsibilities include the following:
Charities report non-cash contributions on a Form 990-series annual return and its associated Schedule M, if applicable. Refer to the Form 990 and Schedule M instructions for more information.
Charities must file Form 8282, Donee Information Return, if they sell, exchange or otherwise dispose of charitable deduction property (or any portion thereof) – such as the sale of virtual currency for real currency as described in FAQ #4 – within three years after the date they originally received the property and give the original donor a copy of the form. See the instructions on Form 8282 for more information.
Q38. Will I have to recognize income, gain, or loss if I own multiple digital wallets, accounts, or addresses capable of holding virtual currency and transfer my virtual currency from one to another?
A38. No. If you transfer virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you, then the transfer is a non-taxable event, even if you receive an information return from an exchange or platform as a result of the transfer.
Q39. I own multiple units of one kind of virtual currency, some of which were acquired at different times and have different basis amounts. If I sell, exchange, or otherwise dispose of some units of that virtual currency, can I choose which units are deemed sold, exchanged, or otherwise disposed of?
A39. Yes. You may choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if you can specifically identify which unit or units of virtual currency are involved in the transaction and substantiate your basis in those units.
Q40. How do I identify a specific unit of virtual currency?
A40. You may identify a specific unit of virtual currency either by documenting the specific unit’s unique digital identifier such as a private key, public key, and address, or by records showing the transaction information for all units of a specific virtual currency, such as Bitcoin, held in a single account, wallet, or address. This information must show (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.
Q41. How do I account for a sale, exchange, or other disposition of units of virtual currency if I do not specifically identify the units?
A41. If you do not identify specific units of virtual currency, the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order beginning with the earliest unit of the virtual currency you purchased or acquired; that is, on a first in, first out (FIFO) basis.
Q42. If I engage in a transaction involving virtual currency but do not receive a payee statement or information return such as a Form W-2 or Form 1099, when must I report my income, gain, or loss on my Federal income tax return?
A42. You must report income, gain, or loss from all taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction, regardless of the amount or whether you receive a payee statement or information return.
Q43. Where do I report my capital gain or loss from virtual currency?
A43. You must report most sales and other capital transactions and calculate capital gain or loss in accordance with IRS forms and instructions, including on Form 8949, Sales and Other Dispositions of Capital Assets, and then summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses.
Q44. Where do I report my ordinary income from virtual currency?
A44. You must report ordinary income from virtual currency on Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income PDF, as applicable.
Q45. Where can I find more information about the tax treatment of virtual currency?
A45. Information on virtual currency is available at IRS.gov/virtualcurrency. Many questions about the tax treatment of virtual currency can be answered by referring to Notice 2014-21 PDF and Rev. Rul. 2019-24 PDF.
Q46. What records do I need to maintain regarding my transactions in virtual currency?
A46. The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns. You should therefore maintain, for example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency