Times are changing. Upon the birth of my daughter six months ago, one of her grandmother’s thought, ‘I don’t want to just buy her some jewellery that sits in a cupboard for decades until her 21st birthday. I want to buy her some cryptocurrency!’ Even as parents, we thought, let’s buy her some crypto, just for the heck of it, and not touch it until she’s old enough to do what she wants with her earnings (or the lack thereof, potentially).
Whether you are a believer in crypto being a currency or an asset, it is unshakable today as a potential medium for investment, purchases and a whole lot of speculation. But an aspect that is more often than not underplayed, are the tax ramifications that have largely passed unaddressed, and will be addressed in formal tax laws in 2018 budgets.
The US’s Internal Revenue Service (IRS) addressed the taxation of virtual currency transactions with the issuance of Notice 2014-21. It states that virtual currency is treated as property for federal tax purposes. This means that depending on your particular circumstances, cryptocurrencies such as Bitcoin, Ether, Ripple, and the 1,000s of other alt-coins, can be classified as business property, investment property, or personal property. Gains or losses are recognized every time that Bitcoin is used to purchase goods or services, for example.
This brings a very complex new aspect into the investment and also the use cases of cryptocurrencies.
The Basis & Characterisation of crypto gains vs losses for taxation
Without diving too deep into the details of how taxation will ultimately be configured for varying countries and jurisdiction, there is one basic principle that will apply universally. The Basis is generally defined as the price you purchased your crypto at, and the gain naturally is the appreciation in value either as an investment or as part of the ultimate spend of the crypto. So for instance, if you bought a Bitcoin for $10,000 and then used the same Bitcoin to buy a car for $15,000, your realised gain is $5,000.
You may consider that straightforward enough, but it gets tricky. Using the property structure, technically every use of a cryptocurrency for purchase of goods of services becomes a uniquely taxable event, as you would need to calculate the basis and gain for every specific token you have purchased. That means a Bitcoin bought in Dec 2017, is treated differently from one bought in Jan 2018.
Further complicating life, your Bitcoin purchased for investment or as part of a business, is treated completely differently if you were using Bitcoin as an individual for purchasing goods and services. A loss in value, say Bitcoin going from $20,000 – $8,000 between two purchases, would be considered a loss that could be tax deductible as an investment or for a business, but have zero tax deductibility as an individual. This is a rather gloomy outlook when you consider the number of people who just bought crypto to get into the game, had a mountain to climb in trying to figure out how to open a wallet, an exchange account, trade, store, and ultimately cash out or spend it. The lines get very blurry as to what was an investment and what was personal. If you are a Bitcoin miner, and pain in Bitcoin, this counts as a business, so any loss of $ value would be tax deductible.
When considering multiple touch points of crypto-asset purchases, sales, and spends, which Bitcoin token are you spending in which moment? Individual tokens have unique taxable metrics to consider. So would you be taxed on a FIFO (First in, First out), or LIFO (Last in, First out) basis? Would you even have the choice in picking which one based on the version that was most beneficial to you? As is the case with all taxation, short term and long term capital gains and losses are also compounded into an individuals taxable income calculation. The sheer complexity of tax law in general, means that accountants are going to be very busy making sense of this mashup going forward.
If you still wonder why regulators have taken so long to regulate cryptocurrencies, you need to look no further than the enigma of taxation.