How Taxpayers and Tax Professional Can Determine Fair Market Value Using Cost Basis for Cryptocurrencies.
**This article has been updated to reflect the latest crypto taxation guidance from the IRS, as of October 16th, 2019**
The long awaited arrival of guidance came unexpectedly, with the IRS issuing a much anticipated direction on how taxpayers can handle taxation for crypto accumulated through income from mining, air drops, hard forks, or the sale of goods and services.
This comes off the heels of the May 2019 notice when the IRS put forth 10,000 letters stating that the agency will be launching much needed guidance for calculating taxes owed on cryptocurrency holdings.
The seemingly ancient 2014 guidance that was left in limbo created more questions than answers, and the world of cryptocurrency has grown dramatically more complex since.
The Three Key Points In IRS Announcement:
- Understanding the tax liabilities created by cryptocurrency forks & airdrops
- The acceptable methods of valuing cryptocurrency received as income
- How to calculate taxable gains when selling cryptocurrencies.
Even though the procurement of cryptocurrencies via blockchain forks and airdrops is not entirely the choice of the holder, the fact that they received an asset with a noted value means every fork and airdrop needs to be accounted for.
The new IRS guidance for cryptocurrency forks and airdrops means that any cryptocurrency owned or received via hard fork or airdrop, regardless of consent, are the result of taxable events. The amount of tax owed per asset is determined by the amount spent to acquire it.
What does this mean?
Essentially, all crypto owned or received via hard fork or airdrops, regardless of consent, are taxable events according to the new IRS policy. The amount of tax owed per asset is determined by the amount spent to aquire it.
One new concern does arise over the concept of owning/controlling coins with inherent value. If a sinnister airdrop were to occur, an investor/user may suffer the unexpected consequences – a giant tax liability. However, this will be within reason as the investor/user would only be liable for the fresh income at fair market value when the asset was initially received.
Fortunately, most forks typically are produced with a low evaluation. In time, these nuances will be quelled with proper framework
“I think every crypto company, investor and tax professionals especially, are full of excitement and nervousness as this new guidance will surely answer some questions but will leave many with an entirely new set of queries. But this is part of the industry’s growing pains. The Blox R&D team is already at work integrating these new legal regulation into the Blox crypto asset management platform.” Said Alon Muroch, CEO and CO-Founder of Blox.io
Most professionals in the crypto space know of the tumultuous scenarios where protocol changes sparked internal conflicts leading to the splintering of cryptocurrencies, most notably, Ethereum Classic and Bitcoin Case. One potential consequence of this newly founded guidance is that if a hard fork should occur in a blockchain network, taxpayers could end up owing penalties on these “forked” currencies they have received in the past, as they are now considered taxable events by the U.S IRS.
It seems as if these new answers truly have splintered even more confused questions that will play a significant role in how taxation proactively and retroactively operates for investors and crypto holders of anytype.
Taxation By Asset Class
One of the most pressing challenges in crypto is primarily reserved for the professionals responsible for the cryptocurrency bookkeeping, accounting, tax preparation and asset management sectors.
The IRS announcement seemed to have reached the first stage of determining cryptocurrency cost basis to measure fair market value for digital assets and their taxable events. According to the IRS: “The value of the crypto purchased on an exchange is determined by the amount the exchange sold it for in U.S. dollars. The income basis, in this case, will include commissions, fees and other costs of the purchase.”
For example, crypto purchased via peer-to-peer exchange (Bitsquare) or a decentralized exchange (IDAX), it is now feasible to leverage a crypto price index to identify fair market value, in accordance with IRS’s new official guidance.
Additionally, when selling crypto, taxpayers can identify the coins they are disposing of.
This is done by monitoring and tracking a coins specific digital ID such as public/private keys, addresses and records displaying the transaction information for all assets in a single account or address.
The newly recommended cost basis calculation method has been designated as FIFO (First In, First Out). However, professionals can choose to apply to others, should they wish. This is exceptionally crucial for today’s confused and overwhelmed crypto accounting and tax professionals for investors, businesses and institutions. This will finally serve as the concrete and legally official foundation for cost basis calculations, industry-wide. A welcomed victory for the crypto finance professional community.
“For many industry professionals, this recent IRS news is a welcome ray of sunshine to help illuminate the future potential of cryptocurrency and its ability to receive more regulation. This will only help to propel the industry into its next iteration and change the way we understand digital assets for the future.” Said Adam Efrima, Co-Founder of Blox.
More Questions for the Future?
While most of the IRS news is welcomed with open arms to the crypto universe, there are several enthusiasts and investors that remain unhappy. Those select users who chose to spend their crypto coins on simple and everyday purchases such as coffee or clothing will not have any tax exemptions for transactions below a certain threshold.
This means that paying a person for a service will absolutely result in a capital gain or loss, which is calculated by the small or large difference in fair market value of the service received and adjusted basis in the virtual currency exchanged for. In clearer words, this will still create a taxable event for small purchases.
For some, this is not news. Any purchase of goods and services have already been considered taxable when the IRS issued its initial guidance in 2014. This almost antiquated document said digital currencies were to be treated as property and not currency, from a tax perspective. This meant that users were out of luck for tax-free day-to-day purchases, discouraging the use of crypto for traditional purchases in the “real-world”.
Taxable vs Non-Taxable Events
Transacting In Crypto
Any type of buying, selling, trading and transacting with cryptocurrencies are considered taxable events. Additionally, purchasing one type of crypto for another, such as buying Ethereum with Bitcoin, is also taxable.
In the eyes of the IRS, cryptocurrency is referred to as property, therefore the IRS considers HODLing crypto (holding crypto for long periods of time) for over one year as a taxable event.
For cryptocurrency mining operations, the constant volume of transactions will almost always create a taxable event. However if coins or digital assets are transferred internally. Internal transfers are classified as non-taxable crypto events.
Converting Crypto to Fiat
The conversion of crypto into fiat is a taxable event. Using the best tools to monitor and record all transactions helps to identify conversions cost basis in reference to fiat value for more accurate tax scenario.
Receiving A Crypto Salary
For many crypto companies, it is becoming popular to pay employee salaries in fiat currencies, using a businesses personal crypto funds. But ultimately, employees or freelancers receiving payment in crypto must report their earnings as they are classified as a taxable event.
Crypto Tax & Accounting Professionals
On October 10th, tax and accounting professionals and firms for cryptocurrencies woke up to a bit of comfort and confusion. Blox is here to help empower them with the 7 most important tools for crypto accounting, tax preparation and asset management for businesses of any size. Blox understands that these heroic industry professionals will need powerful tools capable of solving all of their specific backoffice and crypto financial needs, especially in accordance with this new IRS regulation.
“Blox was built to be flexible and adapt quickly to be in line with the most up-to-date guidance on regulation for cost basis calculation and recording of taxable income, and meet the requirements our customers demand – from simple small investors to large multi-billion dollar corporations.” Said Keren Tow-Aizic, CFO of Blox.
Blox Is A Platform You Can Count On
In our latest article on Bitcoin Magazine, we share a much needed diagram to help cryptocurrency users, investors and professionals to quickly and easily understand taxable and non-taxable crypto events.
For those early investors or professionals that remain unsure on where to start for calculating your cryptocurrency taxes, we have an informative blog on how to prepare your cryptocurrency taxes to help guide you along. When you are ready to engage with a crypto tax advisor such as an accountant or tax professional, we also have a list of the top crypto accounting and tax firms you should know about.
To learn more about the Blox, the industry-leading platform for cryptocurrency accounting, tax preparation and asset management, we would be happy to set up a demo to show you the powerful platform in action. From A to Z, everything you need for cryptocurrency finance starts with Blox.