To File or Not to File? Some Thoughts on Crypto Tax Returns as We Have Entered 2019
For some people, the end of the year means holiday festivities and relaxation. This is not necessarily the case for crypto traders though, as the last day of December concluded a year of big ups and downs, leaving little time for the reporting of earnings.
How likely is it that crypto owners will endeavor to file their crypto tax returns in 2019?
Well, we don’t believe that there will be mass adoption in the near future, with ambiguous approaches to accounting and extreme price fluctuations in the cryptocurrency markets being just some of the reasons.
An Ununiformed Approach to Centralizing the Decentralized World
The prospect, and then scattered implementation of crypto taxation has long been a source of fear, anxiety and confusion for traders, tax professionals and government officials alike.
Even without considering the crazy volatility associated with the crypto market, the sheer volume of trades means that it is not that easy to keep an eye on everything without using advanced algorithms.
Add to that the need to record the gains and losses from every single transaction, (something that lies at the very core of any fiat tax return).
Declaring crypto income thus becomes a very complex and confusing procedure, with no one being 100% sure what conforming or not conforming to it implies.
Nonetheless, governments all over the world have made crypto regulation one of their first priorities. Think of the recent G7 and G20 summits, or the frequent news reports about yet another country adopting cryptocurrencies.
In reality, the will of governments isn’t matching up to reality, making industry clarity something that it is still far off.
For instance, in the US there are at least two ways in which virtual currencies can be treated. The IRS seeks to tax crypto traders as if they were trading investment property, while the SEC sees crypto as a security, which receives more favorable treatment.
On top of that, the IRS obliges regulated exchanges such as Coinbase to reveal accounts’ identities and credit card details, scaring those who do not comply with civil and criminal penalties. Other countries tend to also adopt this approach. However, it remains questionable as to exactly how effective this attempt to legalize crypto earnings will turn out to be, without freaking out traders.
Price too High to Come Out of the Shadows
Let us have a quick look at the three traditional accounting methods that might be applied to crypto taxes in the U.S.:
- FIFO (First-In, First-Out);
- LIFO (Last-In, First-Out);
- Specific Identification.
FIFO is the preferred method for long-term gains, loved by investors due to the fact that it results in nearly two times lower tax compared to the amount paid on short-term gains. With short-term volatile assets like cryptocurrencies, it works differently.
Imagine having bought some BTC for $1,000 and then some more for $5,000 and then $10,000. The oldest, and the cheapest one, must be sold first, meaning that you will be taxed on the most expensive ones that come next.
If you were unlucky enough to acquire BTC at its peak and have seen its drastic fall in the ensuing months, the tax liable to be paid makes for somber reading. A good example of such a situation is that of the US student whose assets severely devalued (from $880,000 to $125,000 this November), while his tax liability stood at $400,000.
LIFO is on the other extreme. For instance, with the same amount of BTC acquired for $1,000, $5,000 and then $10,000 over a period of time, you would first sell the last BTC, which is the most expensive one. It would work better for you, as your old, cheaper BTC will lay the basis for taxation.
This sounds good, but not for the IRS, which isn’t enthusiastic about accepting this approach to crypto taxation.
Seeing crypto as property transactions, the IRS insists on using Specific Identification. In simple words, this method is based on clear identification of which cryptocurrencies are used for trading, and which are simply held, appreciating and depreciating without any action taken. This changes the nature of the tax, with the latter receiving more favorable treatment. The main limitation of this method, however, is that crypto trading has not been fully institutionalized, yet. Crypto traders operate online independently, without referring to brokers, or communicating with exchanges, which makes the possibility of defining rules and procedures for the Specific Identification method next to none.
With the total market cap standing at over $100bn even in these times of hardship, crypto trading remains an appetizing slice of the revenue pie for tax authorities around the world.
As we have just entered 2019, however, the status quo seems too raw and unclear for crypto traders and holders to accurately declare their gains.
What we see at the moment is a multitude of interpretations of the very nature of cryptocurrencies, and three traditional accounting methods, which are not yet fit for tackling this new decentralized reality.