Coin Swaps Taxable Under Current IRS Rules
Submitted by– Mario Costanz, CEO
Until recently, many cryptocurrency investors have largely ignored the IRS. In 2015, the tax agency received only around 800 returns reporting cryptocurrency activity, despite the fact that Bitcoin ended the year with a market capitalization of over $3.2 billion that year. This obvious under-reporting has attracted the ire of the IRS, which has filed and won an enforcement action against Coinbase for the identities of many crypto tax evaders with the rest in the works.
Not everyone however, fails to report their cryptocurrency gains to the IRS because they’re trying to avoid taxes. Many virtual currency investors are legitimately confused about which transactions are taxable. This confusion has led to the perpetuation of rumors in the cryptocurrency community that some common digital currency transactions are actually tax exempt For example, some cryptocurrency investors believe that coin-for-coin exchanges are not taxable. Unfortunately, this is a myth that can land you in serious hot water with the IRS.
Like-Kind Exchanges and Coin-for-Coin Swaps
For years, the online rumor mill recycled a myth that coin-for-coin exchanges fall into a tax loophole known as a “like-kind” exchange. In 2017, a like-kind exchange involved trading one kind of business or investment asset for another. For example, if you owned a furniture store and swapped out a bedroom set in a color that your customers detest for another furniture set in a more attractive shade, you could pay no taxes on the exchange. Tax liability arises when you sell the bedroom set, but so long as the furniture is of the same nature and character as the pieces you exchanged it for, you could defer paying taxes on the sculpture until it sells.
Some investors who sold cryptocurrency prior to 2018 have been under the misunderstanding that those sales should be covered by the like-kind exchange exemption. They base this argument on the fact that cryptocurrencies have the same nature and character, which had been the key terms triggering the like-kind exchange rule in Section 1031 of the Internal Revenue Code. However, this is not how the IRS treats virtual currencies.
Dispensing of your Bitcoin – whether for U.S. dollars or other virtual currency – is a taxable event. This is true whether you use your crypto to buy a cup of coffee or the hottest new altcoin. The transaction does not qualify as a swap of property-for-property. Rather, it’s treated as a sale immediately followed by a purchase. As tempting as it may be, don’t buy in to the rumors regarding coin-for-coin swaps and the like-kind exchange rule. Doing so can land you on the short road to the auditor’s desk.
Tax Reform Clarifies Like-Kind Exchanges
For investors planning to claim the like-kind exchange rule for cryptocurrency trades in the future, the 2018 federal tax reform has rained on their parades. The new tax law expressly limits like-kind exchanges to apply to real estate only. This closed the like-kind exchange loophole entirely, at least so far as some might have incorrectly thought that it apply to cryptocurrencies in past years.
Under the like-kind exchange rule, the IRS allows some investors to swap one business asset for another. However, trading one cryptocurrency for another does not qualify as an investment transaction exempt from tax liability as a like-kind exchange. Just a few crypto trades per day throughout 2017 can give rise to thousands of transactions that need to be reported on your tax returns this year.
The IRS requires investors to submit records showing every time they sold, traded, or spent their virtual currency assets. This has created some unexpected problems for taxpayers used to quick-and-easy 1040 returns. What’s worse, most of the popular tax preparation software limits the number of transactions you can report in a given year. As a result, many cryptocurrency traders are finding themselves in need of a good accountant – and quick! However, this may be a blessing in disguise.
The tax laws are changing, and the IRS is bearing down on the crypto community in search of unreported income. Working with an accountant is an effective way of making sure you’re reporting your trades properly this tax season. While nobody likes paying their tax bill, it’s well worth it to stay on the right side of the IRS.
About the Author
Mario “The Problem Solver” Costanz is a lifelong entrepreneur and has had built and sold a number of successful businesses in the internet, restaurant, real estate, and income tax preparation industry. He was named to the “One to Watch” section of Accounting Today’s 2017 Top 100 Most Influential in Accounting List. More information and contact can be found at https://CryptoTaxPrep.com and https://linkedin.com/in/mariocostanz.