The IRS reports that less than 1,000 taxpayers reported sales of virtual currency on their tax returns between 2013 and 2015. This is just a fraction of the virtual currency transactions, even though the IRS announced in Notice 2014-21 that virtual currency is property (not like foreign currency), so the sale of a Bitcoin (for example) is essentially the same as a sale of a share of stock.

In Information Release 2018-17 issued in March 2018, the IRS reiterated this position. They also noted that an enforcement summons had been approved on Coinbase, the largest virtual currency intermediary, producing trading activity for more than 13,000 accounts.

Since virtual currency is treated as property, each separate unit of virtual currency is its own separate asset, as a separate stock holding, with its own basis and holding period. The resulting tax reporting obligations for significant traders of virtual currency can surprise them considerably.

Trades. There are many types of virtual currency – Bitcoin is only the most well-known. Since these holdings are treated as property, the trade of 1 Bitcoin for 2 Ethereum (for example) is not a tax-free transaction, any more than the trade of 1 share of Apple for 3 shares of Dell. The trade of 1 Bitcoin for2 Ethereum is a Schedule D long or short-term sale of Bitcoin, at a gain or loss, with the proceeds used to purchase a different capital asset – 2 Ethereum – with a new basis and the start of a new holding period.

There is no concrete basis for this, but it can be argued that a pre-2018 trade of virtual currencies is a like-kind exchange. Since the currency is considered property, and there is no publishing prohibition on this position, such a stance seems defensible. However, after 2017 the Tax Cuts and Jobs Act provides that only real estate is eligible for like-kind exchanges. However, the more conservative taxpayers might now want to take this position.

Mining. Mining involves earning virtual currency by using your computer to validate currency transactions and maintain the virtual ledger. If the taxpayer is involved in mining, ordinary income is generated based on the fair market value of virtual currency received from mining activities. This activity is reported on Schedule C and is subject to income and self-employment taxes. Mining-related expenses for computer hardware, software, and internet access can be significant. This fair market value becomes the basis of that unit of currency going forward.

R. Milton Howell III, CPA, CSEP
R. Milton Howell III, CPA, CSEP

Milton is a tax partner experienced in taxation issues including, tax research for both open and closed transactions, structuring complex tax transactions, estate and income tax planning, and representing clients before tax authorities. Milton regularly writes and reviews articles in local, regional, and national publications on tax matters and spends significant time monitoring current tax issues and legislation.

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