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Good to Know: Cryptocurrency Tax Myths Can Hurt You

At one time in the not so distant past, the sky was the limit (where have investors heard that before?) for cryptocurrency. Back then, it seemed like all of the cool kids had cryptocurrency and subsequently, despite ups and downs, its popularity continues. But what is the attraction of this phenomenon? Three potential explanations follow.

hack

Hack resistant – the “crypto” in cryptocurrency represents cryptography. Just in case you’re not a secret agent working for one of the 3-letter agencies (CIA, NSA, FBI and who knows how many more), cryptography has been described as the science of writing secrets and keeping them secret.

Digital currency mimics real currency in many ways. For example, you can purchase goods or services from merchants who accept whatever flavor of cryptocurrency you own. You can also receive payment in cryptocurrency for goods and services you sell.

bitcoin
big-govern

No big brother – no centralized authority, such as the government, controls cryptocurrency.

Disclaimer – this not is not a promotion of cryptocurrencies and is neither investment advice nor tax advice. This blog is posted to raise your awareness of key issues in this often misunderstood cryptocurrency investment and tax arena.  Be aware that significant investment risk abounds.

How significant is the investment risk? One of the roughly 1,500 cryptocurrencies available – Bitcoin – was priced at $15,000 per coin in January of 2018.  Fast forward to January of 2019. Bitcoin had fallen to $3,400 per coin. That’s a breathtaking loss of over 75% in one year.  Investors that bought in at $15,000 and panic-sold at $3,400 locked in a breathtaking loss of about $3 out of every $4 invested. Bitcoin has since recovered to a degree but that’s cold comfort for those who sold at $3,400.

What’s my point?  Cryptocurrency investors should brace themselves for volatility.

Now let’s talk taxes. Tax myths here can be hazardous to your financial health. For example:

  • Misconception: You do not have to report income to the IRS when you sell something and accept cryptocurrency as payment.This risky move may be motivated by an “IRS doesn’t know” strategy or under the dubious theory that these payments are not really income in the eyes of the IRS.

    • Fact – All income from the sale of goods or services, whether paid in real U.S. dollars, digital currency or chickens must be reported to your friends at the IRS. BTW, the IRS recently announced a major push to crack down on taxpayers trying to game the Internal Revenue Code this way. If you know a guy who knows a guy that failed to report such income, he or she should stop doing what they’re doing right now and contact a tax professional.
  • Misconception:  Cryptocurrency investment gains are taxed as ordinary income.

    • Fact: The IRS considers these assets as property, not currency.  Investment gains are taxed as capital gains.  That mean that gains could be taxed at those lovely long-term capital rates if you’ve held the cryptocurrency for at least one year and a day before you sell it.
  • Misconception: Cryptocurrency investment losses are not deductible.  This misconception turned out to be highly damaging to investors losing money in 2018’s free fall of certain cryptocurrencies.

    • Fact: Investment losses are deductible as capital losses. Capital losses are used to offset any capital gains. But what if you have more capital losses than capital gains this year?  You can deduct, if married filing jointly, only $3,000 against other income. But the losses in excess of $3,000 aren’t lost forever – they carry over to future tax years.

As a closing note, these financial products are highly sophisticated and complex. Questions about specific client transactions or planned transactions should be directed to competent tax and investment professionals. Here’s our bottom line – don’t let tax myths and misconceptions lead your clients open to audit, tax assessment, penalty, and interest.