Everyone has started to take notice of Cryptocurrency. On February 18, the market capitalization of Bitcoin crossed the 1 Trillion-dollar threshold. On February 22, gold had an estimated market capitalization of 10 Trillian dollars. That means that the largest cryptocurrency currently stands at 10 % of the market value of gold.[1] Institutional investors have also started to become involved in what was previously a niche asset. Indeed, Canada now allows exchange-traded funds that invest directly in cryptocurrencies. In the United States, Greyscale offers a trust investment for direct bitcoin holdings. [2]
The IRS response to this new type of asset may be well suited for the institutional investor and speculators but does not help the consumer that has immersed themselves into a blockchain culture. The IRS treats all virtual currencies as property that is subject to reporting on disposition.[3] If you are merely trading cryptocurrency pairs on an exchange, e.g. you buy bitcoin at the current market rate for $100 US dollars, this works well. You have a broker that is keeping track of all the transactions. If you sell the bitcoin later for United States dollars (“USD”) or trade it for another cryptocurrency, that also makes sense. An active trader will have a large ledger, but keeping that ledger is similar to how you would operate with any investment, including investments in foreign currency.
Nevertheless, not all holders of cryptocurrency have the sole motive of investment. Many want to use cryptocurrencies in regular commerce. Based on current IRS treatment, this means that if you buy your lunch with bitcoin, you are going to recognize a gain or loss on that transaction. Individual consumers will not want to keep a ledger of all those transactions.
Moreover, some transactions will be native cryptocurrency transactions. That is, a consumer may buy a block of tokens to gain access to some resource. Based on current marketing conditions, the price of those tokens changes rapidly. Nevertheless, when you use the token, you will still have either a gain or loss based on the price you paid for the token versus its current price. Keeping track of these transactions would pose a heavy burden on the technology adapt consumer.
Taxpayers can have some solace. If you merely buy and hold cryptocurrency (or “hodl” if you prefer), then you may treat them like any other capital asset. That is, you don’t have to report gains or losses until disposition. Additionally, the IRS recently issued guidance indicating that merely transferring cryptocurrency from one wallet to another wallet would not be taxable if the type of cryptocurrency does not change form.[4]
In addition to issuing guidance, the IRS has also stepped up its level of enforcement. For the 2019 tax year, the IRS placed a question on Schedule 1 asking taxpayers whether they have engaged in any cryptocurrency transactions. For 2020, they moved this question to a more conspicuous location. Hopefully, the increased enforcement will also come with increased policy and guidance which will allow consumers to use cryptocurrency in its intended fashion and not subject taxpayers to onerous record-keeping requirements.
[1] Jafar, B. (2021, Feb 22) The total market cap of the world’s largest cryptocurrency stands at around $1.04 trillion. Finance Magnates https://www.financemagnates.com/cryptocurrency/news/bitcoin-crosses-10-market-cap-of-mined-gold/
[2] Balentine, C. and Potter, S. (2021 Feb. 21) Raging Success of First Bitcoin Fund Shows Who Leads ETF Market. Yahoo Finance Retrieved February 23, 2021, from https://finance.yahoo.com/news/raging-success-first-bitcoin-fund-120000310.html
[3] Internal Revenue Bulletin: 2014-16 IRS Retrieved February 23, 2021, from https://www.irs.gov/irb/2014-16_IRB#NOT-2014-21
[4] Frequently Asked Questions on Virtual Currency Transactions IRS Retrieved February 23, 2021, from https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions