The IRS Has Yet to Update Tax Implication on Crypto Trading

The first round of US tax season has come and gone, and for some there is still a lot of ambiguity related to cryptocurrencies. This week, congress sent a strongly worded letter to the Internal Revenue Service stating that there was an urgent need to describe the current and future policy. The legislators, led Tom Emmer from Minnesota, are calling for the IRS to update the guidance it published in 2014. There remains ambiguity on a number of important questions about the federal taxation of cryptocurrencies. Emmer and his colleagues say there’s need for additional guidance.

How Do You Handle Capital Gains

The number one question is how to handle capital gains on cryptocurrencies. Many view cryptocurrencies as currencies and not alternative currencies. If you live in the US and the value of the dollar rises, you don’t pay a capital gain every time you purchase an item with dollars. The guidance from the IRS states that you need to treat cryptocurrencies like property. You do not pay an unrealized capital gain if the value increases, but if you buy something, you need to keep track of the price where you purchased the item. The value of your cryptocurrency when you purchase a good or service will be translated to a profit or loss, and need to be reported as a gain or a loss on your tax returns.

Unfortunately, the IRS has not specified how you should determine this profit and loss value on crypto trading. For example, is it first in first out? This is problematic, since many cryptocurrencies are listed on multiple exchanges, and prices are not uniform. Congress sees a need for the IRS to be more specific. For example, if you buy bitcoin on XYZ exchange, that should be the exchange that you use to value your digital currency transaction. As you can imagine, asking individuals to keep track of the price where on the exchange of initial record is difficult and there is no way for the IRS to confirm this there is no specific time that you are supposed to mark as your closing price.

When a Cryptocurrency Splits

The lawmakers also raised an issue surrounding a split in an exchange into two different coins. For example, Bitcoin cash was created from Bitcoin when the community around the networks became divided over specific technical changes. When this happens, how is the coin valued?  The IRS will need to do a deep dive into this issue as cryptocurrencies become more mainstream.  Bitcoin Cash itself split into two in 2018. When a chain splits, holders of the original coin are entitled to the same value of the new coin. Is that capital gains or income and how should it be taxed?

This is an Urgent Problem

The confusion about how to tax cryptocurrencies is an urgent problem. It goes deeper than determining the capital gains tax or splits in coins. Current digital currencies are looked at a property, as opposed to futures or over the counter products which have a mark to market tax scenario. The letter from lawmakers requests a written response describing the IRS’s plans to provide additional guidance on these issues by May 15. This is unlikely to occur.

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