Planning with Cryptocurrency -Part 1 How is Cryptocurrency Taxed?

Planning with Cryptocurrency -Part 1 How is Cryptocurrency Taxed?

    

Tax planning with Cryptocurrency can be tricky.  Due to the adoption of cryptocurrency by many financial institutions, the acceptance as a payment method for Companies and the meteoric rise (and drop) in price, many of our clients are asking us some fundamental questions about this class of assets.

Fundamental tax questions about this class of assets:

  • How is cryptocurrency taxed?
  • My cryptocurrency splits or forked. What are the tax implications?
  • If I sell it, how do I minimize the tax effect?
  • What happens if I contribute it to a partnership or corporation? What do I have to look out for?
  • If I want to donate it, what do I have to do and what do I have to look out for?
  • How do I protect it from being stolen?
  • How do I do incorporate these alternative assets in my estate planning?
  • What do I need to tell my CPA and my estate attorney about where I hold it?

For many years, we have advised our high net worth clients and their families on a variety of cryptocurrency issues.  Most of our clients started getting into crypto currency in the middle of the 2010’s and other are now starting to invest.  In most cases, our clients are either holding on to their investments or gifting them to their family members or charity.

Our primary focus is to act as their lifestyle advisor by assisting high net worth families in preserving wealth, effectively transferring wealth to the next generation, educating them and their children on how to utilize the value of achieving family objectives, and social development goals through impact investing.

We will be covering bullet points II thru VIII above in our next series of articles.

 

How it is Treated (taxed) by the IRS and Why does it Matter?

Cryptocurrencies for the most part are treated as property for tax purposes and not treated as currency or (fiat currency).   This is important because it enables the taxpayer to receive capital gain or loss treatment when it is sold or exchanged.

However, there are a few exceptions:

  • Petro (PTR) Venezuela
  • Sovereign (SOV) Republic of the Marshall Islands

 

In the two cases above when these are sold or exchange, ordinary income and loss treatment will result.  In these two cases, the cryptocurrency was issued by a government and therefore is classified as a currency.   It will be interesting to watch when other governments issue their own cryptocurrency or when stable coins are issued as this trend continues.

How Does One Determine the Fair Market Value of Cryptocurrency?

The fair market value of the cryptocurrency at the time of purchase:

  • is determined by using the amount on the date and time that you received it and recorded on the distributed ledger.

 

  • If the transaction is facilitated by a centralized or decentralized cryptocurrency exchange but is not recorded on a distributed ledger or is otherwise an off-chain transaction, then the fair market value is the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an on-chain transaction.

Character of Income Recognized and Rate of Tax

The taxation of cryptocurrency depends on how you received it and what you did with it after you received it.    There are three ways that it may be taxed:

  • Ordinary income or loss- Taxed at regular tax rates and may be subject to self-employment tax.
  • Capital gain or loss:
    • Short Term (held for 1 year or less)- taxed at regular tax rates plus 3.8% Medicare tax.
    • Long term (held for more than 1 year)-taxed at 20% plus 3.8% Medicare tax rate.
      • Currently, as of March 2021, cryptocurrency is not taxed as a collectible at 28% plus 3.8% Medicare tax.
    • Non-taxable

 

Receiving Cryptocurrency and Tax Character of the Transaction

                Ordinary Income Treatment

  • Payment received in cryptocurrency for inventory goods or services performed in the ordinary course of a trade or business:
    • Ordinary income which may be subject to self-employment tax measured by the value of the cryptocurrency you received.
    • If your inventory is cryptocurrency, then ordinary income is:
    • measured by the difference of the value of the cryptocurrency on the date it is recorded as given up on the distributed ledger less:
    • the cost of cryptocurrency given up.
    • Inventory treatment depends on your intent.
    • Examples:
      • Broker/Dealers
      • Miners with intent to sell them on a regular and continuous basis.

Capital Gain or Loss Treatment Tax

  • Payment received for property that you held for investment:
    • Short term or long term capital gain or loss depending on how long you have held the property.
      • Gain or loss measured by the difference of the value of the cryptocurrency received less:
      • the cost of the property given up.

Capital Gain but no Capital Loss Treatment

  • Payment received for property that you held for personal use.
    • Short term or long term capital gain (but no loss) depending on how long you have held the cryptocurrency.
      • Measured by the difference of the value of the cryptocurrency received and the basis of the property given up.

 

  • Exchange of cryptocurrency for another cryptocurrency
    • Held for investment– capital gain or loss either Short-term or Long term depending on how long you held the cryptocurrency that you exchanged.
      • Gain or loss measured by the difference of the value of the cryptocurrency received and the basis of the property given up.
    • Held as inventory -ordinary gain.
    • Like kind exchanges of cryptocurrency are no longer allowed and can no longer defer tax.

 

  • Gift- non-taxable

 

  • Cryptocurrency splits or Forks- Covered in Part II of our series.

 

Paying with Cryptocurrency and Tax Character of the Transaction

Capital Gain but no Capital Loss Treatment

  • Used to pay for personal goods and services:
    • Short term or long term capital gain depending on how long you have held the cryptocurrency.
    • Measured by the difference of the value of the cryptocurrency on the date it is recorded as given up on the distributed ledger and the cost of cryptocurrency given up.
  • Losses are not allowed for these types of transactions.
    • If intent to hold the cryptocurrency was to pay for personal items.

Ordinary Loss Treatment

  • Used to pay business expenses:
  • ordinary loss measured by the value of the cryptocurrency at the time you used to pay for the business expense.
  • You also will have a capital gain or loss if you held the cryptocurrency as investment:
    • either short-term or long term depending on how long you held the crypto that you used to pay for the expense.
    • measured by the difference of the value of the cryptocurrency on the date it is recorded as given up on the distributed ledger and the cost of cryptocurrency given up.
  • You also will have an ordinary gain or loss if you held the cryptocurrency as inventory.

 

Capital Gain or Loss Treatment

  • Used to purchase other investments:
    • Short term or long term capital gain depending on how long you have held the cryptocurrency.
    • Measured by the difference of the value of the cryptocurrency on the date it is recorded as given up on the distributed ledger and the cost of cryptocurrency given up.

 

  • For charitable contributions- Covered in Part V of our series

 

  • For gifts other than to charitable organizations-Covered in Part VII of our series

 

Look for our other cryptocurrency articles in this series.  Since we our lifestyle advisors, let us know how we can assist you to achieve your lifestyle objectives.   Please contact us if you are considering large transactions in cryptocurrency.

Please let us know how you liked this article. Feel free to share it with others.  Be sure to look for our other articles in this series by Steve Singer.

As lifestyle advisors, let us know how we can assist you to achieve your lifestyle objectives.   Please contact us if you are considering large transactions in cryptocurrency.

We hope you found this article about planning with cryptocurrency helpful.  If you have questions or need expert tax or family office advice that’s refreshingly objective (we never sell investments), please contact Steve Singer directly or  contact us or visit our Family office page  or our website at www.GROCO.com.  Unfortunately, we no longer give advice to other tax professionals gratis.

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Considerately yours,

Steve Singer, CPA, Partner GROCO.com,

GROCO, GROCO Tax, GROCO Technology, GROCO Advisory Services, GROCO Consulting Services, GROCO Relationship Services, GROCO Consulting/Advisory Services, GROCO Family Office Wealth, and GROCO Famil

Part II Tax Implications of Splits Forks Airdrops and Much More

 

 

/Steven Singer
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