By Sean Stein Smith, CPA, DBA
The changes embedded within the $1.9 trillion American Rescue Plan has attracted the attention of tax practitioners this spring, but it is important to not lose sight of other tax issues, particularly those tied to cryptoassets. With the price of bitcoin (among others) experiencing a substantial run-up during the last few months of 2020, and with more individuals gaining exposure to cryptoassets via apps like Robinhood, the potential tax issues are substantial. Even with all the conversation and debates surrounding cryptocurrencies that have occurred during this bull market, there are tax issues that may present stumbling blocks for practitioners and clients.
The following is not an all-inclusive listing of potential cryptoasset tax issues. Always consult with a tax expert who is familiar with both cryptoasset taxes and the specific issues linked to the taxpayer in question.
You Might Not Have to Check “Yes” on the 1040
The IRS made waves when it indicated that all taxpayers who had engaged in any crypto “transactions” would have to disclose that on their 1040 by checking a box to that effect. The meaning of “transactions” seems to have been left deliberately vague, leading many taxpayers and preparers to assume that any cryptoasset purchase or exchange needed to be disclosed.
Later, the IRS seemed to clarify this issue via FAQ #5, which says a purchase of cryptocurrencies using fiat currency need not be disclosed. Other exchanges and transactions still must be reported.
Section 1031 Does Not Apply
Even though like-kind exchange treatment has been disallowed, and retroactively applied, for several years, the issue comes up every tax season. Even if two cryptocurrencies are exchanged or swapped for one another, with no “sale” or “purchase” indicated, this generates a taxable event. For example, if a taxpayer exchanged 1 bitcoin for an equivalent (at that time) number of some other cryptocurrency, this would generate a taxable event that would have to be disclosed and reported.
In other words, any exchange or change in ownership of cryptocurrencies is going to generate a taxable event, be it a gain or a loss, for taxpayers involved.
Multiple Wallets Are Not Taxable
Something that can be confused with the above point is transfer between “wallets.” To be clear, if a taxpayer has multiple cryptowallets (accounts), and cryptoassets are moved between these wallets during the year, this does not generate a taxable event. A taxpayer can have as many cryptowallets as desired and move funds between these wallets during the year without incurring any tax obligation. This holds true even if the taxpayer receives an information return or other documentation from the exchange or platform in question.
Crypto Gifts Are Allowed
Following some initial confusion around the implications of charitable contributions and gifts denominated in cryptoassets, clarification has arrived: bona fide gifts are allowed. As a general rule, gifts received from another taxpayers, assuming that these gifts are truly bona fide in nature (no service is expected nor is the gift ever expected to be returned or reciprocated), these gifts are excluded from taxable income. Be sure to consult your tax preparer regarding bona fide gift rules and how they pertain to cryptocurrencies for additional clarification.
Stablecoins Are Treated the Same
Stablecoins are type of cryptoasset that tries to provide price stability by linking its value to an external asset. Stablecoins have move rapidly from a relatively small part of the crypto conversation to a mainstream component. Even though the primary selling point of these cryptoassets is the lower volatility associated with them, these cryptoassets are treated the same as the much more volatile assets, such as bitcoin. In other words, even if stablecoins form the method by which a taxpayer is conducting cryptotransactions, these events need to be disclosed and may generate tax obligations.
The tax landscape surrounding cryptocurrencies is evolving fast, and I’ve not even touched on new applications and use cases ,such as decentralized finance, nonfungible tokens, and the associated valuation and income effects of these new ideas. Practitioners must be proactive, stay informed, and be willing to embrace these news ideas. Not only is this a professional responsibility, but it also will allow practitioners to deliver value to clients in new and unexpected ways moving forward.
Sean Stein Smith, CPA, DBA, is a professor at the City University of New York – Lehman College, with his award-winning research having been featured in dozens of articles and books on emerging technologies. He is also the chair of NJCPA’s Emerging Technologies Interest Group, and can be reached at email@example.com or on Twitter @seansteinsmith.
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