How Crypto Is Taxed in the US: A Taxpayer's Dilemma

Many investors who did not know how to hedge their cryptocurrency investments saw these investments lose value from the market highs of 2017.Facing the deadline to report their taxes by April 15, 2019, United States individual taxpayers may wonder what their United States tax reporting obligations are if they held, donated or sold/exchanged their cryptocurrencies at a loss during 2018.A taxpayer's dilemmaLet's imagine a potential 2019 taxpayer sitting in front of his tax advisor and feeling embarrassed to tell him that he had lost 90 percent of a 100K investment in cryptocurrencies when the cryptocurrency markets experienced a downturn during 2018, with leading cryptocurrencies like Bitcoin and Ethereum down 80 percent or more.

The tax advisor assured the taxpayer that this would give rise to a taxable event only if he sold, exchanged or donated his cryptocurrency during 2018, and that these things would need to be reported on his U.S. tax return - noting that holding cryptocurrencies would not give rise to a taxable event but may give rise to tax-reporting requirements if the cryptocurrencies were held in a foreign financial account.

Cryptocurrency hodlersIf a taxpayer for 2018 has not sold, exchanged or donated the cryptocurrency he bought at the end of 2017 or beginning of 2018 and is still holding them, then there is no taxable event to report on his U.S. tax return.

Tax-reporting requirements would arise if the taxpayer held these cryptocurrencies in a foreign financial account and if mandatory financial thresholds were met under Foreign Bank Account Report and Foreign Account Tax Compliance Act reporting requirements, according to a letter from the American Institute of Certified Public Accountants to the Internal Revenue Service.

Specific information should be given in Part V. Noncompliance with FATCA could subject a taxpayer to taxes, severe penalties in excess of the unreported foreign assets, and exclusion from access to U.S. markets, which could include a regulated cryptocurrency derivatives clearing market.

Cryptocurrency charitable donationsA taxpayer may feel generous and decide to donate their cryptocurrencies to a tax code Section 501(c)(3) tax-exempt charity of their choice, to give the charity a large gift.

Cryptocurrency investment sold or exchanged at a lossIf a taxpayer held the cryptocurrency as an investment and sold it during 2018, he will be taxed just like bonds or stocks at capital gains rate, which is calculated by subtracting the cost of the asset at the time of purchase from the amount at which it was sold.

A taxpayer can use his cryptocurrency investment capital losses to offset gains and deduct the difference on his tax return, up to $3,000 per year.

According to a survey prepared by personal finance company Credit Karma, only around half of cryptocurrency investors who lost $1.7 billion during 2018 plan to report their losses to the IRS.Their reasons for staying quiet is partially tied to not knowing if they can deduct their losses, believing they don't have to, or that they neglected to report cryptocurrency gains in past years and now are afraid to report their cryptocurrency losses.

Taxpayers who have neglected to pay their cryptocurrency-related U.S. taxes and who file their applicable U.S. tax returns should do so by April 15, 2019 to avoid interest, penalties, and even jail time for tax evasion or, worse, for tax fraud, since "Cryptocurrencies are a key part of the Joint Chiefs of Global Tax Enforcement's work," Don Fort, chief of the Criminal Investigation Department at the IRS said at a Joint Chiefs of Global Tax Enforcement meeting in Amsterdam, citing the risk that such coins are used in the U.S. to avoid paying taxes.