Cryptocurrencies continue to be hot in the new year. Bitcoin has continued to excite investors. Of course, there are tax matters to be considered when dealing with any investment. Tax lawyer Rob Wood offers some helpful advice for investors who have virtual currencies in their portfolios, a subject also discussed in his article, “Crypto Tax Tips To Start 2018 Right.”
Wood notes that many investors have made a lot of money in cryptocurrencies, “and any time you make money, the IRS . . . wants a piece.” It is important to remember to pay the IRS. Everyone has to file a tax return. The IRS relies on forms like W2s and 1099s to track income earned by taxpayers.
There are 1099 requirements for cryptocurrencies as well. However, Wood says, taxpayers need to understand that they may have income whether or not they receive a 1099 reporting that income. If you sell something for more money than you paid for it, you have income of some kind. That’s why it is important to keep good records. There are many ways to keep records, but the key is to adopt some system and use it.
When someone sells a cryptocurrency for more than the purchase price, there is obviously gain, and it will have to be reported. The question, Wood says, is what is being sold. For example, if you have ten Bitcoin and you sell one, which one did you sell? It’s important to keep identification information in your records so that you know what you are selling, just as you would with a share of stock or a parcel of real estate. “Try to think like the government will think.”
Another issue involves lending cryptocurrencies. Lending money to someone is generally not a taxable event. It’s important for investors to understand, Wood notes, that the IRS treats cryptocurrency as property, not money. If you lend a Bitcoin and get the same one back, there may be no tax consequences. But what if it’s not the same one? The IRS might well treat this as a sale of property.
Another issue to think about is charitable contributions and making a gift of a Bitcoin. Such a gift, Wood says, could confer a big tax benefit to the donor. Giving an asset whose value has appreciated generally allows the donor to claim the market value of the asset. This can be a big tax saver for someone with a lot of assets.
Wood emphasizes that it is also important for cryptocurrency investors to understand that like-kind exchanges are not tax-free. That is, swapping one kind of cryptocurrency for another will be a taxable event in the eyes of the IRS. There are questions about how such a transaction should be reported, but the transfer is not tax-free.
Wood has one final reminder for every cryptocurrency investor: recordkeeping. The IRS does audit taxpayers from time to time, and the audit may come well after the time a return was filed. In order to sustain one’s position during an audit, it will be critical to have records that support the tax return. If someone uses digital records kept in the cloud, it would be prudent to back up the records and perhaps to keep a copy in the tax file.
Robert W. Wood is the Managing Partner of Wood LLP, San Francisco. Often listed among the best tax lawyers in America, Wood has broad experience in corporate, partnership and individual tax matters. Concerning the tax treatment of litigation settlements and judgments, he is perhaps the preeminent tax lawyer in the United States. He is also an authority on merger and acquisition tax matters, tax opinions, offshore account and entity disclosures, and many types of tax controversies. The Legal Broadcast Network is a featured network of Sequence Media Group.