On November 2, 2018, a Reddit user submitted a post to the /r/tax subreddit claiming that they were stuck in a somewhat precarious proposition with their taxes.
Crypto-to-crypto trades: Taxable events
The individual, an American college student, said that they decided to start dabbling in cryptocurrency investments sometime in early 2017 after hearing about the market’s growth potential from a friend. The decision turned out to be a rather good one, at least for the time being. In the course of a few months, they managed to convert their $5,000 initial investment into $880,000 by the end of the year. The Reddit post continued:
“I went down the rabbit hole and struck gold a few times, hitting 10x’s on multiple [altcoins]… I brought my 5k initial all the way up to a $880k portfolio in December 2017.”
Failing to time the market, however, they did not cash out any part of the portfolio until it was too late. Furthermore, they did not account for any of the tax implications arising out of the several crypto-to-crypto trades made throughout 2017.
According to the user, most of their trading was done through Coinbase, a cryptocurrency exchange based in the United States. As of the time of the post, their total known tax liability sat at approximately $400,000.
With the market’s poor performance since the start of 2018 though, the user claims that their current portfolio is worth a mere $125,000, a “far cry” from the highs of close to a million dollars. They explained:
“I gambled in more than a few bad ICOs to start 2018, had some money in coins that absolutely plummeted with no chance of recovering, etc.”
While most other Reddit users have since encouraged the poster to seek the advice of a certified accountant or tax professional, some have explained that the tax liability will have to be paid in full, regardless of the losses incurred. Since the IRS calculates taxes on each calendar year separately, any losses born in 2018 cannot directly influence the final owed amount.
Furthermore, since the individual made repeated trades within a short time frame, their investments are treated as short-term capital returns and subject to a higher tax rate.
Many don’t realize that each crypto-to-crypto trade is considered to be a taxable event. As a result, the individual in question has no choice but to file their tax return with the IRS to prevent being hit by further penalties. As for the $400,000 figure, they will be forced to either pay in full or negotiate a deal with the agency. Reddit user /u/NeoChosen pointed out the latter:
“Eventually, you could potentially work out an Offer in Compromise with the IRS and the FTB, since you would probably qualify. This requires meeting a lot of really stringent conditions.”
The IRS and Coinbase
While the early days of the cryptocurrency market did not involve much due diligence on the part of exchanges, that has rapidly begun to change in recent years. In November 2017, for instance, Coinbase was ordered to report tax information belonging to around 15,000 of its users. According to a report by The Verge:
“For each account, the company has been asked to provide the IRS with the user’s name, birth date, address, and taxpayer ID, along with records of all account activity and any associated account statements.”
Cryptocurrency exchanges first came under the tax regulator’s scanner in late 2016, when the IRS claimed that companies were not complying with the relevant regulation. At the time, they also wrote, “The taxpayers being investigated have not been or may not be complying with U.S. internal revenue laws requiring the reporting of taxable income from virtual-currency transactions.” Ultimately, Coinbase was forced to hand over personal information of all customers that made trades exceeding $20,000 between 2013 and 2015.
Coinbase has taken the matter rather seriously and has long been issuing its customers all necessary tax-related documentation. The user from the Reddit post was also issued a 1099-K form for his trades from 2017, to which he linked in the thread. According to the filing, they had completed a total of 1,563 transactions throughout the year, grossing exactly $592,700.