21st Century Taxation Problems: The IRS and Bitcoin Cryptocurrency

Like many things to do with technology, cryptocurrency has evolved much faster than the laws designed to regulate it. Since there is money involved, the level of governmental regulations attempting to define the laws around it is that much higher. One of the most pressing and most difficult areas of regulation involving cryptocurrency is that of taxation.

First, what are cryptocurrencies? They are essentially virtual currency that can be bought and sold through online exchanges, but do not actually exist in real form, although they can be exchanged for traditional currency. They can also be bartered for services or other cryptocurrencies. The most well-known cryptocurrencies are Bitcoin and Ether, but as with most things internet based, they are only the beginning.

Once cryptocurrency came onto the scene, the IRS naturally looked at whether and how they should be taxed. Of course, the IRS decided that cryptocurrencies should be taxed since they are bought and sold like any other product or commodity. To determine how to tax them, the IRS then classified them as “property” rather than currency. Thus, cryptocurrencies are akin to real estate, investment property (but not stocks), and similar property that are taxed on their sale or purchase, and in the case of investments, upon gains.

Of course, there are still a lot of questions that have not been answered. For example, much cryptocurrency is held by U.S. owners in foreign bank accounts—like currency. However, for tax purposes, the IRS does not consider cryptocurrency to be currency. So, do U.S. owners who hold cryptocurrency in foreign bank accounts have to report that cryptocurrency on a Report of Foreign Bank and Financial Accounts (FBAR)? Do these cryptocurrencies become actual currency when they are being held in these accounts such that they must be disclosed if they are valued over $10,000? In this matter, the IRS’s actions have been more telling than their words. There have been recent enforcement actions against cryptocurrency owners who have not disclosed their cryptocurrency on FBAR reports which would lead to the conclusion that the answer is yes.

Another question has emerged with the amendment of Section 1031 of the Internal Revenue Code to change the reference to “property” to “real property.” As of January 1, 2018, only like-kind exchanges of real property will be allowed to avoid tax liability on the sale of the first asset. It is questionable whether cryptocurrencies would have qualified for like-kind exchanges even before the change in the wording, as it was never clear that Bitcoin was considered like-kind to XRP or other cryptocurrencies. Not only are the valuations of these currencies wildly different, their very definition is different. Both are digital currencies, but they are created and tracked differently. Nevertheless, with the addition of the word “real” to property in Section 1031, like-kind exchanges are now absolutely not applicable to cryptocurrencies.

The law is also silent on the tax implications of crypto-forking, which is where a cryptocurrency essentially is split into two new distinct coins with different ledges and code, but are still from the same blockchain. Would this be treated as a corporation spinning off a business? We do not know for sure, as the IRS has issued no guidance.  However, to the extent cryptocurrencies are not stock, this is probably not a likely application of the tax rules to this phenomenon.

The attorneys at Weisberg Kainen Mark are on the forefront of the legal implications of cryptocurrency and are ready to help cryptocurrency owners understand their tax liabilities and responsibilities in this brave new tech world. Contact us today to get started.

Written by Weisberg Kainen Mark, PL

Weisberg Kainen Mark, PL

Weisberg Kainen Mark, PL is a Miami-based law firm focused on providing comprehensive legal support to individuals and corporate entities caught up in tax controversies or charged with a criminal act. As experienced trial lawyers with a passion for justice, our firm provides clients with compelling advocacy, attorney availability, and creative solutions to your tax or criminal law matters.