If you haven’t found yourself living under a boulder over the past few weeks, then you may have likely heard about the US Tax Reform and its effects on everyone, ranging from large industries to individuals holding blue collar jobs (where it may be argued that some segments are left better off than the others).
The ones who support the reform, including the likes of President Donald Trump and the majority of Capitol Hill Republicans, have been singing praises of what the reform holds and how it is only aimed to make paying taxes a clean and easy process.
However, despite those claims and the shower of praises thrown at the reform by the Republicans, a few aspects of paying taxes in the post-reform era still remain unclear. Cryptocurrency is just one of many aspects that have not been specifically addressed by the reform.
The proposed bill has passed both the House of Representatives and the Senate. It now waits for the process of being compiled into a final bill. The avenues that have not been mentioned in the bill itself could very well be subject to surprising rule changes when the discussions regarding them are brought to the table, which could then result in surprising results for holders of Bitcoin and other cryptocurrencies.
What is clear so far is that the Senate version of the bill also proposes a “first-in, first-out” (FIFO) accounting framework that has the potential of further complicating the reporting of cryptocurrency tokens and purchases. Furthermore, both versions of the bill have scratched the “like-kind” exchange mechanism that many cryptocurrency holders have utilized in the past.
Members of the Congressional Blockchain Caucus had introduced the Cryptocurrency Tax Fairness Act, which was left out of both the House of Representatives and the Senate version of the bill. This means that neither version changes the existing capital gains tax rates that cryptocurrency is subject to pursuant to the IRS’ 2014 guidance.
However, this could also hint at a last-minute modification that could come at the expense of the cryptocurrency holders, who would not know what hit them until it very well has.
First-In, First-Out Mechanism
What could have the most impact on the holders of cryptocurrencies is the first-in, first-out accounting mechanism for specified securities.
While this, for now, is only a provision within the Senate version, it could mean that as the requirement relates to determining the cost basis of an asset sold, with the oldest goods in one’s inventory selling first.
What one normally does is to tell their broker to sell the highest-cost assets first. However, what is being proposed by the Senate means that you cannot utilize that feature or process anymore and that you have to use first-in, first-out method instead.
This essentially means that the first assets that you acquired will have to be the first ones that you were treated as selling. For instance, someone purchased 1 bitcoin at $1,000 in 2013 and then went to buy another at $10,000 last month. When they decided to sell one at the price of $15,000, the person will need to sell the one bought first (which is the $1,000 one), and then realize $14,000 worth of taxable gains. They’d likely rather sell the $10,000 one first, and realize only $5,000 of taxable gains.
While bitcoin has been categorized as a commodity by the Commodities Futures Trading Commission (CFTC), one couldn’t help but wonder if this provision – as it only applies to securities – would have an effect on bitcoin.
As per some industry officials, it is very likely for bitcoin to get caught up in this, especially how Bitcoin Futures started trading this week.
If Bitcoin does get a pass, then there are several initial coin offering (ICO) issuers, who have designed their tokens as securities. In addition to them, the issuers that the SEC continues to go after will fall under this FIFO requirement as well.
However, as overwhelming as FIFO sounds like, one cannot say for certain whether the provision will make it to the final bill that is signed into law.,
To assess the matter, since FIFO was only in the Senate’s version and both the House and the Senate are currently in the process of having their respective drafts reconciled, FIFO might not be in the final bill. However, even if it does make it to the bill somehow, there could be a silver lining on the FIFO front.
For instance, the provision only applies account-by-account, which means that if the oldest bitcoins an individual owns are stored in a separate account from the bitcoins they want to sell, then the rule does not apply.
It was suggested by a tax partner that if you decide to sell bitcoin in 2018, you are very likely going to be treated as selling the first one that you bought.
They further stated that it’s better to take such coins off the exchange and to hold them directly, only delivering the one that you want to sell, once you want to sell it.
It was also suggested that traders could consider selling off a significant portion of their cryptocurrency holdings before the end of the year to minimize the capital gains realized.
Additional thoughts on the bill
As some of the cryptocurrency community have suggested, the final version of the bill could certainly do a 360 from its current stance to something that is far graver for virtual currency holders. It is being hinted that the move could be deferring capital gains taxes on property, by swapping one asset for a similar asset via a so-called 1031 like-kind exchange.
Employing such exchanges has been a common tactic in crypto trading circles in years past, but both the House and Senate bills limit this provision solely to real estate transactions.
Such exchanges have been known as an often-utilized strategy in cryptocurrency trading, but both the House and Senate bills currently limit this solely to real estate transactions.
A partner and co-chair of the tax group of Steptoe & Johnson in Washington, D.C., Lisa Zarlenga mentioned that:
“A lot of people have been taking the position that when they swap tokens from one type of token to another type of token or one cryptocurrency to another cryptocurrency, that’s a like-kind exchange.”
By swapping between cryptocurrencies, asset owners forego the short-term capital gains tax, which is the same as ordinary income tax rates, only to pay a lower, yet, a long-term capital gains tax rate of 20 percent once the assets are sold.
While the current law remains unclear on whether this mechanism can hold true for cryptocurrencies, a case could be argued for it in the instances of swaps of assets that originate from the same blockchain, such as bitcoin to bitcoin cash.
However, it is then explored as a possibility that if the proposals go through, then taking this position on any exchange of cryptocurrencies would cause an elimination of the ability altogether.
The final version of the bill will tell the whole story
While various speculations could be made about how the bill would include or exclude reforms related to cryptocurrencies in its final version, nothing could be said with certainty until that final version makes itself to the hands of the officials.
Until then, assessing the situation and taking any necessary measures that you could in order to act in accordance with whatever the bill holds would be the logical way to go.