By Jeff Stimpson, FA-mag.com - Your high-net-worth clients may be tempted to invest by the headline prices of bitcoin and other cryptocurrencies, but new court decisions and legislation put tax minefields in such investments.
“While cryptocurrency investing is a hot topic and trend largely due to its decentralized approach to currency, it’s not exempt from the far-reaching power of the IRS,” said Tyler DeWitt, an attorney and CPA in Memphis, Tenn.
The IRS recently won a court decision to compel a major cryptocurrency exchange to disclose investor information for those with at least the equivalent of $20,000 in any one transaction type in any one of three recent tax years. Tax reform recently passed by Congress also eliminates most tax-deferred like-kind exchanges -- one favorite tactic for bitcoin investors who claimed that virtual and real currency were essentially similar.
The IRS recently affirmed that virtual currency transactions are taxable, similar to transactions in any other type of property. The agency also seems poised to crack down on the lack of reporting of cryptocurrency gains or losses, according to Bob Phillips, CPA, CFP, and managing principal of Spectrum Management Group, Indianapolis.
In the recent court case, documents indicated that only 800 to 900 taxpayers reported gains related to bitcoin in each of the years 2013 to 2015, “yet there are 14,000 Coinbase [exchange] users that bought, sold, sent or received at least $20,000 worth of bitcoin in a given year,” Phillips said. “There appears to be a lot of underreporting of taxable income.”
Such disclosure could affect wealthy clients who failed to report taxable income or transactions involving bitcoin, litecoin or ethereum, among other types of cryptocurrency. Exchange of cryptocurrency for traditional currency now triggers a gain or loss as if your client had bought or sold a stock or a bond.
Tracking such metrics as basis, fair market value and taxable income for trades of wildly fluctuating and paperless cryptocurrency can be almost impossible. Your clients potentially caught by the new tax rules may want to file amended returns for previous years.
“Many taxpayers want to report properly their crypto tax information, and it would be nice if the IRS would implement third-party reporting like they have for stocks or bonds with the exchanges so that taxpayers would have information that helps them,” said Randy Tarpey CPA with Sickler Tarpey & Associates in Tyrone, Penn. “Most participants in cryptocurrency need to find a logical, easy way to track and report their activities to the IRS annually.”
DeWitt advises HNW cryptocurrency investors to make “a good faith effort” to report taxable income and maintain records. “The worst mistake an investor could make would be intentionally underreport income from cryptocurrency transactions or, worse, fail to report such income entirely,” he said. “HNW clients with significant unreported income from cryptocurrency investments are prime targets for audits and possibly criminal investigations. I recommend using tracking software created specifically for cryptocurrency investors.”
Price volatility in this virtual gold rush may temp investors yet make recordkeeping difficult. Bitcoins were worth pennies for about two years until April 2011. By the following year the price had jumped to $5 to $10, skyrocketing to almost $1,000 by the end of 2013. The price again climbed steadily beginning in the second quarter of 2017, spiking at nearly $18,000 last December. Today a bitcoin is worth about $7,000. At times bitcoins lost or gained double-digit value in just hours.
Similarly, in just a month litecoin lost half its value from a December 2017 peak of about $375. Ethereum now trades at about $390, down from almost $1,300 in early January.