Analyzing The 2019 Crypto Tax Guidelines

Tyson Cross Episode Highlights

Two Components – Revenue Ruling & FAQ (1:08):

The revenue ruling creates some problems. The FAQ, for the most part, is not too problematic. But – I’d say on the net whole, both maybe create more questions than they answer, unfortunately.

The Revenue Ruling – Airdrops & Forks (2:28):

Revenue Ruling 2019-24 is what the IRS released and specifically it addresses this issue of hard forks and airdrops, which until now has really gone unanswered. There’s been a lot of debate in the tax community about whether hard forks and airdrops are taxable events…whether they satisfy these kinds of requirements that we have from existing law for treating something as a taxable event. The big two are: do you have an ascension to wealth – meaning is the thing you received valuable? Number two, do you have dominion and control over it – meaning are you free to treat it as your own? If those two things are met, then generally speaking, you have taxable income.

The problem is applying those two standards to hard forks or airdrops is actually pretty difficult. The revenue ruling here attempts to make that application – but the problem is that the facts they use are problematic…and don’t seem to really adequately describe a hard fork or an airdrop. This revenue ruling is broken down into two situations where the IRS lays out the facts and then applies the law and reaches a conclusion about whether or not these events are taxable.

They say situation one is not a taxable event because the taxpayer did not receive additional units of virtual currency. But in situation two, the IRS says that it was a taxable event because the taxpayer not only received units of virtual currency from the followup airdrop, but also had dominion and control, because the taxpayer could immediately sell them if he or she wanted to. Situation one is not taxable. Situation two is taxable. So where do most hard forks like the BTC/BCH hard fork fit in? Strictly speaking, if you really took those revenue ruling at face value using the plain language, it doesn’t fit into either one because the BTC/BCH hard fork wasn’t followed by an airdrop.

This revenue ruling, like many issues that have come up with cryptocurrency, puts taxpayers in a really hard spot where they are left yet again guessing what the IRS wants them to do. If you don’t want to have any problems with the IRS in the future, I would tell you to go ahead and report every hard fork and every airdrop as a taxable event.

The IRS FAQ on Virtual Currency Transactions – Specific Identification Methods (22:30):

One of the big questions that’s been floating around the virtual currency space now for years is what methods do you use to calculate your cost basis? FIFO (First In First Out) is the default approach for shares of stock – so, kind of unsurprisingly, the IRS said in the FAQ Question #38 that FIFO is the default method also for virtual currency.

What was maybe a little bit surprising is that the IRS also says in Question #37 that you can use specific identification for virtual currency. This was actually a little surprising to me because the requirements for using specific identification for shares of stock is actually a little burdensome. In Question #37, the IRS sets what I would consider a pretty low bar to use specific identification for cryptocurrency transactions.

Specific identification would mean that instead of just assuming you’re selling your first Bitcoin, the oldest Bitcoin in your wallet, you can actually look at all of your holdings and pick which one you’re selling when you do a sale. So you could pick the one with the highest cost basis if you wanted (HCFO), or you could pick the newest one in your wallet (LIFO). So this opens up a lot of possibilities for taxpayers to be a little more strategic about how their gains are reported. Using specific identification, taxpayers can maybe choose the cost basis method that causes them to have the lowest amount of capital gains.

Most people listening should be relatively happy to hear that specific identification is possible. The question is what do you have to do to be allowed to use it? Question #37 says that you have to have records showing the transaction information for all units of the specific virtual currency held in a single account wallet or address. The question goes on to say that the information must show four things: the date and time each unit was acquired, your cost basis and the fair market value of each unit at the time it was acquired, the time and date each unit was sold or otherwise disposed of, and the fair market value of each unit when it was sold or disposed of. Well those are four things that we pretty much have already, every time we do a transaction with virtual currency – if you trade on coin on a Poloniex, when you download your transaction report, it’s going to show all four of those things every time.

Unchanged Guidelines & Unanswered Questions (29:43):

I would say most things weren’t changed by this guidance. And that’s one of the things that’s maybe a little disappointing about the updated FAQ and the Revenue Ruling. A lot of it we already knew, especially in the FAQ – it kind of just flushes out some of the smaller points. But generally, the basic principles that we’ve been operating under for the last five years are all still in place.

We know that basically any transaction conducted with virtual currency is a taxable event and it’s generally capital gains and reported on Schedule D of your tax return. That part of it is still the same – nothing changed. The FAQ also addresses things like mining. We’ve known for a while that you have ordinary income based on the value of that coin at the time that it is mined. That logic would apply to staking rewards and other similar receipts of virtual currency. Also if you get paid in virtual currency, you know that’s taxable. Whether you’re an employee, or you’re a business selling goods or services, those are all taxable events.

There are still some big unanswered questions that we have and hopefully we get some guidance on that soon. I think the big thing they missed, and it’s really disappointing, was the issue about foreign account reporting.We’ve been asking this question now for five years or longer, about whether accounts held at foreign cryptocurrency exchanges are subject to reporting on FBAR or under FATCA on Form 8938. The question is, does an account at a foreign cryptocurrency exchange fall within the definitions used for the FBAR and Form 8938? And the answer is that we don’t know.

Retroactive Guidelines (34:20):

Most IRS rulings are retroactive unless otherwise stated. The Revenue Ruling and FAQ do not identify an exception to that. So I would say that these are retroactive.

Should you go back and amend past years? That’s a tough question to answer. I’d say talk to your tax preparer or advisor and see what they think. A lot of that depends on how much income it was, how much the rest of your income was on your tax return, how much time is left on the statute of limitations. It’s not an easy question to apply generally. But certainly you should look into it because the IRS will be following this revenue ruling retroactively.

Questions from the Community @ 44:50:

Tyson answers questions from social media, Reddit, and from BitcoinTaxes users.

Important Links:

IRS FAQ

Rev. Rul. 2019-24 (PDF)

BitcoinTaxes Summary