Today's high-tech economy is all about reinvention. We've got Tesla reinventing cars, Amazon reinventing delivery, and WeWork turning offices into a "state of consciousness." (Shhh, don't tell Michael Scott.) We've also got Bitcoin and other blockchain-based cryptocurrencies trying to reinvent money. Never mind that most people have no idea how cryptocurrencies actually work. Buying in has become ridiculously easy. Just download an app, find the nearest Bitcoin ATM, feed in a stack of Benjamins, and stuff your online "wallet" with all the "coins" you can afford.
Is Bitcoin really currency? Not yet. True currencies have to serve two functions: a means of exchange, and a store of value. Bitcoin isn't accepted by enough mainstream vendors to overcome its initial sketchy reputation and serve as a true means of exchange. As for the whole "store of value" thing, well, you can buy it before breakfast and lose half your stake by lunch, which means it fails that test, too. So Bitcoin has become largely a speculative playground for white-knuckled tech bros hoping to take down a quick score without having to start their own company.
Back in 2014, the IRS issued Notice 2014-41 treating cryptocurrencies as property. If you buy it at one price, then spend it on something at another, you'll owe tax on any gain from the time you bought it to the time you spent it. With prices bouncing around like that little white ball right before it falls into a roulette wheel, there are lots of gains and losses. (The good news is, if you have the guts to hold your position for more than a year, you'll benefit from lower long-term gain rates.)
Some traders have argued that exchanging one cryptocurrency for another — trading, say, Bitcoin for Ethereum — isn't a "sale" at all, but rather, a "like-kind exchange." The IRS hasn't formally answered that argument, but there are enough problems with it that we can be pretty sure the answer would be "tough noogies." Anyway, the Tax Cuts and Jobs Act of 2017 shot it down entirely by limiting 1031 exchanges to real estate.
Other traders had an even simpler plan, which boiled down to "what happens in the Bitcoin wallet stays in the Bitcoin wallet." That might have worked, too, if the IRS hadn't shown up in the wallet. In 2016, they discovered just 800 to 900 taxpayers had filed Form 8949 to report income from Bitcoin. That seemed awfully low, considering all the hype. So the next year, they served a John Doe summons demanding names and trading records from Coinbase, one of the biggest digital currency wallets. (That's the same kind of summons they served on Swiss Banks to find U.S. depositors.)
Now the IRS has upped the stakes. In June, they sent scary letters to 10,000 traders "suggesting" they verify they filed their taxes correctly or amend their returns. In some cases, they're even sending actual bills. (They've already got the records, so they don't need traders to do the math.) Some of those bills may be based on incorrect assumptions, like taxing gross proceeds rather than net gains. But for traders who don't respond properly, it's probably going to be like Oprah taking over the audit division: "You get an audit! And you get an audit! And you get an audit!!!"
Most people think Bitcoin is still a joke. And it will be, until the day it's not. In the meantime, if you decide to join the party, we have legitimate strategies to help you pay less tax. So be sure to let us know before you buy in, so we can be here to help you cash out!
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John Leidy, EA
DIY Books Coach
It was the third day of the very first income tax course when I realized that it will become my mission to help people understand their taxes better to be able to make better decisions and STOP wasting money on taxes they should not have to pay.