In 2014, the IRS made clear that it considers Bitcoin and other cryptocurrencies to be property, not currency. These convertible virtual currencies, or CVCs, are therefore taxed as capital gains.
In other words, when you sell CVCs, exchange them for other CVCs, or use them to purchase other items, a taxable event occurs. Therefore, with minimal exceptions, you need to pay a tax on the difference in value from when you first obtained the CVC and the time when you sold, exchanged or used it.
This means that taxpayers need to keep excellent records of every CVC transaction they make. For each transaction, you will need to provide the IRS with a basis value — the amount the CVC was worth when you first obtained it. You’ll need this to determine the amount in gains or losses you experienced.
If you mostly use CVCs as investments and rarely sell them, this compliance is not especially complicated. Careful accounting is required, however, for those who frequently buy, sell, loan out, use or exchange cryptocurrencies on a more routine basis. And many taxpayers are out of compliance.
The IRS may have detailed transaction information
According to an Accounting Today contributor, the IRS subpoenaed Coinbase, a U.S.-based CVC dealer, for records on its clients. It has also entered into an international coalition to investigate crimes involving CVCs, such as tax evasion, fraud and money laundering. It has also been sending out warning letters to taxpayers.
For example, approximately 10,000 taxpayers received one of two letters informing them that they may owe capital gains taxes on their cryptocurrency accounts. These letters merely recommended the recipient evaluate their compliance.
A third letter, Letter 6173, tells the taxpayer that the IRS has received information about CVC transactions and instructs them to file or amend their returns. Even those taxpayers who are compliant are required to respond, under oath, with information about how they are already in compliance.
Taxpayers who receive Letter 6173 should be aware that the IRS may have detailed information about your CVC transactions, so they should prepare their responses carefully.
That said, there are a number of complexities in CVC taxation that are not answered clearly by the U.S. Tax Code or its regulations. For example, if you traded one type of CVC for another before tax year 2018, it might qualify as a like-kind transaction under Section 1031. Another example is how cryptocurrency miners should be treated under the law.
If you’ve received Letter 6173 or any communication from the IRS regarding cryptocurrency transactions, you need to talk to an experienced tax attorney to ensure you fully comply with the law.