Cryptocurrency and you (or, what you need to know about Bitcoin, briefly)

This will probably morph into a series of brief posts about Interesting Facts about Cryptocurrency and how to handle it from a business and tax perspective. Most of us are still working through the maze, and of course, the tax landscape continues to shift beneath our feet. This article has been written post-signing of H.R.1, the Tax Cuts and Jobs Act, signed into law in December, 2017.

So what is “cryptocurrency,” anyway? the name itself is a bit of a misnomer, as there’s really nothing “cryptographic” about it. It should really just be called “digital currency,” because that’s what it is, or more to the point, “digital barter units.” In fact, prior to 2013, the US Government apparently did not even have precedent to consider “digital currency” currency as such. This recognition puts the Internal Revenue Service in a precarious situation, because the Service much prefers to treat digital currency as an asset (think capital gain or loss) and specifically not as currency. This, of course, leads to some complications, particularly when utilizing digital currencies for business purposes.

Bitcoin (or BTC) is by far the most common cryptocurrency (crypto) in existence today, though there literally are hundreds of them, and the potential for still more is boundless. Thankfully, we can all consider them of the same ilk (like considering all common stock as one type of security instead of having to consider each company as issuing a different type of ownership certificate).

Accepting crypto as a business may be done in at least a couple of ways:

• Wallet-to-wallet, just as one would do online. The customer provides an address to the seller who then adds that address to his wallet, and the transaction is complete. This may be done device to device, through a QR code on one device to a camera on the other, or any other way to get a string of number and letters (an address) from point A to point B.
• Through a payment gateway for an online transaction. Here, BTC (or any other cryptocurrency) is used just like a credit card payment, usually online. The merchant’s payment gateway accepts the transferred address and adds it to the merchant’s wallet with that gateway. That gateway may then either continue to hold the crypto, transfer it elsewhere (manually or automatically), convert it to a different crypto (e.g., accept Litecoin for the transaction and then immediately convert that to Bitcoin), or convert it to a fiat currency (USD).

From an accounting perspective, a sale was transacted when the crypto was accepted. However, a second transaction, capital in nature, occurs when the crypto is converted to either another crypto (BTC exchanged for LTC) or to a fiat currency (BTC exchanged for USD). Thus, when converting through multiple cryptos before ultimately converting to cash, there may be several capital transactions taking place.

Prior to H.R.1, many traders in cryptos took advantage of an ambiguity (purposeful or not) in the tax code pertaining to exchanges in “like-kind property” or physical assets which were sufficiently similar in nature to be classified as being of the same type (more on the topic). Historically, the most common like-kind exchanges have been in real estate (land-for-land or building-for-building). This provision, originally conceived as Section 202(c) with the Revenue Act of 1921, then changed to 112(b)(1) in 1924, and ultimately, in 1954, Section 1031, which has remained relatively intact (at least insofar as the definition of qualifying property has been concerned) to this day.

While the original Code Section 202(c) did not differentiate between like-kind and non-like-kind, the resulting free-for-all apparently led to the 1924 narrowing and the Section change to 112(b)(1), which also specifically disallowed securities (stocks, bonds, etc.) from being classified as like-kind (making it impossible to perform tax-deferred trades of IBM and Standard Oil stock, for example).

Naturally, none of these revisions to the rules had any provision for assets like cryptos (heck, they weren’t even technically “assets” until 2013!). So, some savvy investors took the position that trading one crypto for another should qualify as a tax-deferred like-kind property exchange under the rules of Code Section 1031.

No more.

H.R.1 specifically changes the wording from “property” to “real property” effectively closing the door on such broad interpretations of the Code. Thus, beginning January 1, 2018, converting BTC into LTC triggers a recognizable event which may be taxable, based upon the price paid for the BTC upon entry. Likewise, converting the resulting LTC to ETH would be recognized as a second trade, possibly taxable, and so forth all the way down the line through the last trade back to USD.

There has been much hype and speculation (the vast majority of which, in this author’s opinion, is completely off-base, irrelevant, and misdirected) concerning the crypto market, with (erroneous – again, in this author’s opinion) comparisons drawn to the stock markets. The next installment in this series will deal with exactly why the old rules no longer apply, why the rise and fall trends of the crypto markets have little to no correlation with the stock markets, and why all of these stock guys are simply missing the point.