And some investors are opting to not pay taxes at all, according to accountants.
In January 2014, Nevada-based attorney Tyson Cross wrote a Reddit post that attempted to make sense of cryptocurrency taxes. Bitcoin had experienced a small boom that year, and the IRS had yet to weigh in on how it should be taxed. Many people were lost when it came to paying the government for their gains.
The IRS has since clarified that virtual currency is to be “treated as property for US federal tax purposes,” meaning any gains between the time bitcoins were bought and when they were sold (due to price deflation) must be treated as capital gains. Yet four years since Cross’s Reddit post, paying cryptocurrency taxes hasn’t gotten much easier. After Bitcoin’s biggest year yet—with a high of $19,000 USD for one bitcoin in December—most clients are getting hit with way more taxes than they anticipated.
In fact, due to unexpectedly high taxes and currently low cryptocurrency prices to pay them with (one bitcoin is now worth $8,000), accountants told me that some investors are avoiding paying taxes on their virtual fortunes until good times return to the markets.
“I would say that most clients underestimate their capital gains,” Cross told me in a phone call. “They think that they made, let’s say $1 million, but when we run the numbers it can come back with $1.5 million. If that’s short term, that’s an extra $3,000 in taxes they weren’t expecting to pay.” In some cases this season, clients ended up owing as much as $1 million more in taxes than expected, Cross said.
Why the disparity in expectations vs reality? There are two main problems, according to several accountants I spoke with: Cryptocurrency holders might not realize that every trade they make is taxable, and many exchanges don’t provide users with detailed transaction histories.
Patrick Camuso, owner of the Charlotte, North Carolina-based firm Camuso CPA, told me in an email that the majority of his new cryptocurrency-holding clients come to him “unaware of like-kind exchange rules.” This leads to them having to pay for “more taxable trades than they’d anticipated,” he wrote.
The IRS lays out like-kind exchange rules in Section 1031, which specify that taxpayers can defer paying taxes on capital gains if they invested those gains in “similar property.” Many cryptocurrency holders figured that trading one altcoin for another could constitute a qualifying exchange, but that’s not the case, according to Camuso. His clients were not happy to learn this, he said.
After all, 2017 was defined by quick and dirty cash grabs, where investors bought into a new ICO token or altcoin, watched the value climb, and then quickly sold it for the next one. Savvy investors did this over and over, gaining big along the way. But simply moving money between tokens didn’t save them from taxation this year.
Making these trades usually means going through a number of exchanges. Coinbase, arguably the most mainstream platform, currently only allows for Bitcoin, Bitcoin Cash, Ethereum, and Litecoin trading. If people want to play the altcoin game, they’d have to move onto additional platforms like Bittrex, Bitfinex, Binance, and Kraken. Cross said his average client has used about five different exchange platforms, though some have gone through as many as 15.
This can introduce confusion in keeping track of transactions and ShapeShift (a popular platform for coin-to-coin conversions) doesn’t provide users with records of their trades, according to Cross. Without records, he and his clients have had to “reconstruct” a year’s worth of trades to the best of their abilities, looking at bank transfers to exchange platforms and factoring in the price of cryptocurrencies at the time of those transfers to ultimately cobble together a record from scattered shards of information.
Some investors are opting to not pay taxes at all.
2017 ended on a high note for most cryptocurrency holders. One bitcoin was worth close to $13,000, and ether—Ethereum’s currency—was over $700. Since then, values have dropped across the board and people who hadn’t turned their cryptocurrency holdings into cash faced the reality of owing money for 2017’s gains while paying with 2018’s coin values. As a result, many opted to “roll the dice,” Andrew Perlin, co-founder of The Crypto CPAs, a firm based in Florida, told Motherboard in a phone call.
“It’s a big theme,” Perlin said, “to take the interest penalty the IRS gives them and wait for the market to go back up.”
This tax season, he’s had to turn away about 20 percent of potential clients because they wanted a way out of paying their fair share of taxes. As a professional CPA, Perlin couldn’t ethically counsel them on how to do this. “They go somewhere where they’ll hear what they want to hear,” Perlin said.
Cross has also seen clients who want to “take their chances” by not filing, he told me, but increasingly crypto-holders have decided to report their full earnings to the IRS since Cross published his Reddit post in 2014. “People were very confident the IRS couldn’t track this stuff [back then],” he said. “The consensus in the cryptocurrency community now is that the Wild West days are coming to an end.”