The Tax Consequences of Failing to Report Cryptocurrency Transactions
March 21, 2019
Host, Dara Albright, interviews Tom Cardinale, Tax Partner at EisnerAmper, to obtain insights and expertise on reasons behind the lack of cryptocurrency tax reporting, the importance as well as the challenges of good recordkeeping in a market that never sleeps, and the tax implications of cryptocurrency loans – a rapidly growing segment of the industry.
Da:Great. I think if we just jump right into it with some questions relating to a lot of what we've been hearing about people failing to report their cryptocurrency gains and losses. To what do you attribute the lack of cryptocurrency tax reporting?
TC:Well, in short, it's a very convoluted process. Right now crypto exchanges aren't like your normal brokerage exchanges where you trade stocks and bonds. It's really its own animal. And crypto exchanges are currently not required to fill out what we call a 1099B, which should report gains and losses like you would have for stock transactions. It's basically every exchange is for themselves, and what they give you could be anywhere from a summary of just what you sold, just the proceeds. Other times you may have to download the entire history for the calendar year of all crypto transactions you made, and it could wind up being thousands of lines of micro transactions. It's an extremely difficult burden to compile all of that data, especially if you're an avid trader. And the other side of it is that because the SEC is still debating itself whether to characterize crypto as a security or a commodity or a utility, they do not have any written rules yet of what crypto exchanges should be providing to traders and taxpayers. So with that, a lot of taxpayers, based on history and the lack of reporting of gains, seem to think they're getting a free ride and they don't have the obligation to report the gains and losses when in actuality they should. I think it's a case of a system in its infancy with currently a lot of burdensome record-keeping requirements. And it's just very difficult for a taxpayer to know, without doing a lot of work themselves, of what gains or losses they incur during the tax year to put on their tax return.
Da:Do you think that requiring the digital currency platforms such as a Coinbase and making them actually issue 1099s to all their customers, would that be helpful in protecting customers and avoid a lot of these future tax consequences?
TC:It absolutely would. Coinbase is a great example. Coinbase does issue a standard 1099 called the 1099K. A 1099K is required if there are any transactions totaling over $20,000 of gross volume and 200 individual transactions. At a minimum, they will give that to any material traders of Crypto, but it will only report the gross volume, meaning the gross proceeds. There is no indication anywhere on those 1099Ks of what the cost is of those cryptos and if there's been a gain or loss. And as I said before, there's no requirement for them to issue a 1099B, which would show all that detail of gains and losses, which ironically was only made a law about 10 years ago for stocks and bonds to report cost basis. Brokerage houses now have to report cost basis, where in the 1990s, 1980s, they weren't required to. It's almost like we're coming to a new cycle, so to speak, with crypto starting out similar to how stock reporting started where it was just proceeds only. So we have a way to go for crypto to report a cost basis. That, I think, collectively is a reason why there's been so few reporting of the transactions by the taxpayer.
Da:That's really interesting. And do you foresee that transaction threshold, the $20K and the 200-plus transactions, changing at any point in the future?
TC:I don't. The $20,000 threshold has been around for several years. They could adjust it upward or maybe downward as a result of the IRS in its ongoing investigations of unreported gains. They may push to lower that threshold. But, as of now, there's been no talk of changing that $20,000 or 200 individual transactions threshold.
Da:So even for smaller investors that are under that threshold, they should still be reporting as well?
Da:Could you discuss some of the importance of good recordkeeping? We started touching upon that in the last question, but why has it been such a challenge, especially when it comes to cryptocurrency transactions?
TC:It's such a convoluted process and I'll even use my own personal experience with crypto, and I've used Coinbase where I go to the website and you have a menu of options on the website and I'm just looking for something like tax center or year-end summary of transactions or gains and loss report. It's very difficult to find anything on that. You will find some certain areas where they summarize your proceeds, but nothing conventional like a 1099B where it gives you the date and summarizes every transaction: the gain, the loss, any transaction fees, etc. You basically have to go the extra step of downloading all of your transactions into it, like a data dump, like a CSV or an Excel-based file, and you have to sort through all of your sale transactions, your purchase transactions and come up with a short- and long-term gain or loss on all those transactions. It's just a lot of work that is a burden on the taxpayer and I think that is one of the reasons impacting the reporting of gains and losses.
Da:Yeah, that's really interesting. Do you think having the 24-hour markets also creates an issue? Meaning at least when we have stocks, we know how it closes on a certain day. It's easier to keep track of.
TC:Yeah. And that's another thing, the crypto market never sleeps. There's never a close where transactions can be settled and summarized. I also have my own regular stock brokerage account and it can give you, on the day of closing, when the stock exchange closes, gives you a summary of your activity of the day, any gains and losses during the day on the realized gains and losses, etc. But you don't have that in crypto because there's never a stopping point. It's a continuous brokerage.
Da:Yeah, we are in definitely a new paradigm here. Let's switch gears for a second and talk a little bit about the crypto currency loan sector. It had been really experiencing some strong growth this year and even as the market declined, many cryptocurrency investors we've seen were reluctant to sell at lower levels. Could you discuss some of the tax implications of crypto currency loans? What do borrowers as well as lenders need to be mindful of?
TC:Sure. And let me give a 30-second overview of how these loans work. I think what lending companies are seeing and the banks are seeing is that the crypto market is starting to stabilize. You're seeing Bitcoin in this tight 3,000 to 4,000 range, almost going on a year now. They're saying that I think this is a good floor that could act as collateral for a loan. You're seeing all these new, not exchanges, but they’re new online marketplaces for lending for individual or small business lending. You would need to deposit your coins, whether it is Bitcoin or some other, into these wallets, let's call them bank wallets, on the websites that are lending you the money. What that money, that crypto, does is it acts as collateral for the loan, but they are holding your crypto.
You're already giving it to them for them to hold in case of a breach or a nonpayment of the loan. There's different percentages of what you would need to put up as collateral. Sometimes it's 80% of the value of the loan; it could be 60%. That all depends on the platform. That's generally how it works and I think the goal of that is to attract more of their business in case crypto goes more mainstream in terms of purchasing items, which has transaction fees. These lenders would like to be the all in one hub for those, for that future business. They're trying to get these people, let's call it into their wallet now in case it branches out into a new revenue stream so they have that customer with them already, even though it just started alone.
In terms of the tax implications, there's two things to remember. If you obtain a loan through one of these crypto lending institutions, the interest on that is not going to be deductible. It's considered a personal loan. It's not backed by your mortgage or your primary home, which has actually been more restrictive from tax reform. They put some more limitations on home mortgage interest, but personal loans you cannot take a deduction for on the interest. That's one thing. The second thing is let's say you have a scenario where you defaulted on this crypto loan and your collateral was not enough to cover it, your crypto collateral, then any access of debt forgiven you had on that loan is taxable to you at ordinary income rates, which is now up to 37% ordinary rate at the federal side, plus you may have it at the state level as well. It could be taxable there.
Da:That's really interesting and I think the whole crypto currency loan sector itself is really an interesting area, the market to keep an eye on. Thank you for providing insight as to the tax implications. Tom, Credit Karma estimates that Americans lost $1.7 billion and had unrealized losses of more than $5 billion in the 2018 crypto bear market. Does that figure seem accurate to you?
TC:To me, it does not. If you look at the crypto boom of 2017 at the end of ‘17, the market cap of all cryptocurrencies worldwide, you'll touch a little over half-a-trillion dollars collectively. Now there was the massive sell off in January and February of ‘18. A lot of that was due to what was reported as selling off to have enough proceeds to pay off the taxes on those gains, but the market in ‘18 steadily kept going down and down to where the market cap at the end of ‘18 was around the $150 billion area. You're going from around $500 billion to $150 billion of market cap, so that's a $350 billion reduction. It's hard to believe that the realized losses would only be $5 billion and the rest would be unrealized. It seems like there was a massive sell off that was recognized transactions. I would estimate that number to be much, much higher than $5 billion or $6 billion.
Da:Which says that most people, even more people than we may even really realize, are failing to report, which is really interesting.
TC:Yes and I don't know of all the details of the study from Credit Karma. I don't know if they were just looking at U.S.-based customers because crypto is a worldwide commodity/security. There's only so much information you could get depending on the foreign country and governments, what they're willing to relay on such a study. As a worldwide crypto market, there's been hundreds of billion dollars lost in ‘18. I think the losses are just much higher, the realized losses are much higher. Then comes to the issue of are these people that have not reported their gains in ‘17, are they now going to come forward and report their losses as a capital loss in 2018? We're waiting to see if that happens. There is a matching principle. You report both gains and losses. While there was no voluntary flood coming from the people that recognize huge gains in ‘17, we may see that flood come from people reporting losses in ‘18.
Da:I agree. It's going to be interesting to see how this plays out. Tom, I would just want to say thank you so much for your expertise. This has really been fantastic insight. I'd like to thank everyone else for listening to EisnerAmper’s podcast series. Please visit Eisneramper.com for more information on this and a host of other topics as well.