For the Defense - Vol. 6 Issue 3 - 36

A number of individuals who own cryptocurrency
received their cryptocurrency through " mining. "
Mining is generating computer code that allows
the block chain ledger to handle additional
transactions. Cryptocurrency miners create code
that permits these additional transactions;
these miners receive some fractional amount of
cryptocurrency for their contribution. Mining has
received some notoriety because the computers
that generate these codes use significant
amounts of electricity. The IRS takes the position
that miners earn income when they receive
cryptocurrency for mining. Mining is a type of selfemployment
just like practicing law, operating a
pizza parlor or selling insurance. Miners must pay
self-employment taxes on their income and can
deduct ordinary and necessary expenses such as
their utility bills.
There are two reoccurring issues in the
cryptocurrency tax area. Taxpayers will buy one
type of cryptocurrency, hold it for a period of
time and then exchange it for a second type of
cryptocurrency. Prior to the 2017 Tax Cut and Jobs
Act, exchanges of all property were subject to
like-kind exchange rules in I.R.C. § 1031. In short,
taxpayers who exchange one piece of property for
another " like-kind " piece of property may defer
the capital gain from the sale of the first asset until
they sell the second asset. For example, a taxpayer
buys 1 unit of Crypto-A for $10,000 and it doubles
in value at which time s/he exchanges it for 1 unit
of Crypto-B for $20,000. The taxpayer's basis in
Crypto-B is still $10,000 not $20,000 and no tax is
paid when the taxpayer exchanges Crypto-A for
Crypto-B. Of course, the taxpayer could also roll
Crypto-B over into Crypto-C and again defer the
recognition of this income.
Effective tax year 2018, as part of this tax
overhaul, the like-kind exchange rules were
narrowed and cryptocurrency was excluded.6
the above scenario, if there were no like-kind
exchange, the taxpayer would owe tax when s/he
sold Crypto-A and purchased Crypto-B.
Prior to 2018, it was believed that almost all
cryptocurrency transactions were " like-kind. "
Recent IRS guidance, however, has suggested the
IRS applies the " like-kind " rules narrowly in this
area.7
This guidance stated that Bitcoin, Ethereum,
and Litecoin, three of the most commonly traded
cryptocurrencies, were
not
like-kind
36 For The Defense l Vol. 6, Issue 3
property.
Thus, individuals who traded cryptocurrency
before 2018 likely have taxable income even if
they had not cashed out their crypto wealth at the
time. After 2018, every cryptocurrency transaction
is taxable.
Another common reoccurring issue involves
individuals who acquired the same type of
cryptocurrency on multiple dates. For example, a
taxpayer may have bought 10 BTC on January 1,
2017 (BTC= $998.33) and 10 more BTC on January
1, 2018 (BTC= $13,657.23). When the taxpayer
sells the 5 BTC on January 1, 2019 (BTC=$3,843),
s/he would prefer to sell his/her 2018 holdings.
The IRS has not issued any guidance on which
accounting method must be used, although the
presumption would be that the taxpayer must use
first in, first out, which means selling the lower
value BTC. Taxpayers may attempt to use other
rules that have been approved for the sale of
fungible corporate stock but the IRS has provided
no guidance authorizing such a position.
Cryptocurrency Is Held in Wallets That Do Not Have
IRS Reporting Requirements
In
Cryptocurrency is typically held in " wallets. "
Individuals can create their own private wallets
- unhosted wallets; or individuals may seek a
commercial service that provides hosted wallets.
Individuals who possess private wallets are
responsible for maintaining the cryptography
key, i.e., a security code. Individuals who own
private wallets operate those wallets at their
own risk because if they lose their cryptography
key, they cannot access the money. Other than
being computer savvy, there is no restriction with
respect to owning a private wallet. As a result,
there is no requirement that someone who owns
a private wallet identify himself/herself to the
counterparty of the transaction. The anonymity
makes it much easier to buy and sell contraband
with cryptocurrency.
Some companies like Coinbase, Kraken and
Poloniex operate hosted wallet services to the
general public. Individuals who hold cryptocurrency
through hosted wallets do not bear the security
risks and do not need to possess any computer
savvy. Companies like Coinbase provide userfriendly
portals that are similar to online banking.
Creating an account is as easy as checking a bank
account balance online.
For the Defense - Vol. 6 Issue 3

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