Understanding How Your Cryptocurrency Will Be Taxed in 2018
By: Luke Roth
Tags: Investing, Cryptocurrency, Taxes, Sentiment, Finance

Image by Flickr.

On Friday December 22nd, President Donald Trump signed into effect a new tax code for the upcoming year. In politics, taxation has become a hot topic for voters when deciding which party to align with, and which presidential candidate to support, but regardless of political affiliation, the new amendments to the tax bill are bad news for all cryptocurrency investors. In an amendment of tax code IRC section 1031 (a)(1) with regards to “like kind exchanges”, significant changes have been made which clearly define cryptocurrency as a taxable commodity. These changes prevented cryptocurrency from falling through a loophole, and made all cryptocurrency transactions taxable.

This tax bill, the first major overhaul signed into effect in thirty years, is absolutely bad for cryptocurrency owners. As of January 1st, all cryptocurrency trades will become taxable events, which includes trading one type of cryptocurrency for another cryptocurrency. This recent update to the tax system prevents cryptocurrency users from taking advantage of a loophole in the prior tax code.

The previous wording allowed for exemptions on “like kind exchanges” which allowed cryptocurrency users to exchange their cryptocurrency for other cryptocurrencies on exchanges without any taxation.

Investors could be taxed on the dollars they converted to cryptocurrency, but once their money was on an exchange or in a digital wallet, it could no longer be taxed, unless the owner used it to purchase something other than cryptocurrency, or exchanged it for dollars. Trades of this kind are known as 1031 exchanges, and have been used by many different people to exchange goods that are not currency, such as furniture or art. Essentially, this 1031 loophole was created to allow trading items between citizens officially legal.

The problem in the new tax bill for cryptocurrency owners is that the new tax bill narrowed the 1031 exemption to exclusively applying to real estate swaps, which clearly does not include cryptocurrency. In 2014, when cryptocurrencies were officially labelled as property for taxation purposes, cryptocurrency trades entered a grey area which allowed most traders a loophole for deferring taxes on their gains through trades. However, since cryptocurrency is treated like property for taxation purposes, and property is subject to capital gains, there are regulations involved within the taxation of these coins, which is the source of the problem.

Prior to the overhaul, cryptocurrency was taxed the regular income tax rate of 10–37% if it was held for less than a year, and it was subject to long term capital gains tax if held for a year or more.

By citing the 1031 like kind exchange rule regarding trades for other cryptocurrencies, investors could claim that they were not spending their coins, but rather exchanging them for something else of the same type, much in the way one might trade books with a friend. By claiming this, investors could defer any taxes on their earnings, since there was not a purchase that brought about the new value, but rather a swap.

To prevent the possibility of any loopholes with cryptocurrency in the future, the new tax bill limits the 1031 law to cover only “real property”, meaning physically tangible property. While cryptocurrency might be real to all us investors, it is not considered real property by the government. The most immediate effect on cryptocurrency is that starting January 1st 2018, every cryptocurrency trade will be taxed at the time of the transaction, which effectively kills off the current loophole.

With many of the most popular coins now well over $100 per share, and many more showing immense promise, the government, under President Trump, is officially claiming their piece of the pie. Whether the new law will actually have any effect will remain to be seen.

From 2013–2015, the IRS discovered that fewer than 1,000 people in the U.S. had paid taxes on their Bitcoin each year, which led to a lawsuit against Coinbase.

The IRS has already expressed a desire to claim more tax dollars from cryptocurrency, so this is of no surprise. The cryptocurrency user base has been notoriously good at shirking the government of their cut, so this tax bill might not have as much of an effect as the government is hoping.

My best advice for this situation: You have two days left to buy without being taxed. Coins across the board are down (read: on sale) and they will definitely be climbing to new heights in 2018. If you decide to put it off until Monday you will certainly be hit with taxes upon your purchase.

What do you think of the new tax bill? Let me know in the comments below!