Crypto might be profitable, however be sure to are prepared for the tax officer
Looking back is 20/20, but when money is at stake, preparation can give investors better foresight. A little over a year and a half ago, Investopedia reported on the panic of many crypto investors who found themselves on the wrong side of the tax official. The article read: “Online forums like Reddit are full of posts listing potential scenarios for concerned investors about tax liabilities pending their previous deals in cryptocoins, potentially making them poorer.”
As the price of Bitcoin (BTC) rises and investors flock to crypto to make money, lawmakers and regulators around the world are taking note. Most recently, the Organization for Economic Co-operation and Development announced a plan to publish a ubiquitous tax standard for its member states, partly aimed at curbing base erosion and shifting profits. Although announcements like these serve as positive signs of intergovernmental cooperation, economic unity, and progress, they feel rather aloof to the average investor. However, understanding the regulations governing digital asset taxation is crucial for U.S. investors as it can, in some cases, mean the difference between wealth and five years in prison with fines of up to $ 250,000.
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A handful of libertarian crypto torchbearers might be inclined to believe that the blockchain’s built-in anonymity privileges could save them from government control, but after all, the Internal Revenue Service is not quick to let go of these matters.
The US tax code and crypto
Digital currencies and tokenized assets are typically a mixed bag under US tax laws. Many investors view Bitcoin as a digital currency, like fiat currencies, which are regularly used by consumers to purchase goods. However, under US tax laws, Bitcoin is actually considered “property” and taxed under capital gains tax if it is sold or used to purchase items or transferred for other digital currencies such as trading Bitcoin for Ether (ETH). For example, buying a home with Bitcoin in the US would trigger a taxable event for capital gains, and exchanging Bitcoin for any other type of asset is considered a sale, just as you could sell securities like a stock.
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It’s difficult to determine why Bitcoin is classified differently from fiat currencies, but precedents in investor use of Bitcoin can give us the answer. The IRS is likely to recognize Bitcoin as a real estate asset, as the popular crypto asset serves as an investment provider for most users rather than a functional currency, as is the case with the US dollar. More importantly, the US government does not recognize these assets as such until further notice, as they are not issued by a central bank. To understand crypto taxation, you need to look into the little details as well.
In contrast to centralized financial systems, decentralized systems require investors to play a far more active role in carefully tracking their investments from the point of purchase to sale or exchange for goods.
At the simplest level, it is more up to the investor to keep track of the purchase date, purchase price, and purchase price for Bitcoin in the event of a sale. In contrast, investment history in traditional, non-digital assets such as stocks or commodities is relatively easy to track due to the meticulous records that brokers keep for clients and their easy accessibility.
Crypto investments and taxes
Aside from the basics, there is one area in particular where many accredited investors miss the mark.
Crypto hedge funds are known for providing lucrative crypto opportunities. While some crypto hedge funds are considered risky due to questions about the liquidity of the crypto market, they may be a better way to invest than buying individual bitcoin shares. And recently they have become increasingly popular over the past year. Big Four’s crypto hedge fund assets under management rose from $ 1 billion in 2018 to over $ 2 billion in 2019, according to Big Four’s accounting firm PricewaterhouseCoopers. Despite investor interest, buyers should be careful.
Compared to traditional assets, it is a completely different ball game when investors for crypto assets are involved. Unlike traditional assets, it is imperative that digital asset hedge funds ask deeper questions about tax considerations. Some questions about crypto investing should be: What kind of property is cryptocurrency x? or Can wagering assets on proof-of-stake networks that offer rewards for wagering qualify as unique income? These are just the basics, but questions like these can easily be lost your mind right now and trigger unintended tax events.
On the other hand, when joining a hedge fund, the standard process is to sign a standard legal entity fund structure, which is often up to 500 pages long. The contract contains tax clauses that explain the effects of an investment in the fund. However, with hundreds of detail pages, investors may not be able to pay close attention to the small details because they may inadvertently be at serious risk of conflict with the IRS at a later date. This is where a tax advisor who is used to a more passive role should come into play.
Due to the unique characteristics of crypto, the role of tax advisor needs to become active rather than passive, as is usually the case. Rather than taking a back seat, tax advisors should be asked to seek advice on investments prior to undertaking them and to play a proactive role in educating investors every step of the way. As a result, investors would be better prepared to file a full and permanent tax return than find themselves on the short end of the staff catching up with the IRS.
When the tax officer knocks, it is better to play it safe and know the regulations. Otherwise, the consequences could be much more severe. More importantly, when investors sign on the dotted line, the tax advisor is in the passenger seat rather than the back seat.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Derek Boirun is an entrepreneur with institutional experience in commercial real estate development, EB-5 capital investments, and blockchain-based investments. Derek is the founder, CEO and director of Realio. He previously founded the American Economic Growth Fund, an EB-5 investment platform focused on raising foreign capital for US real estate projects, and is currently an executive member of the American Economic Growth Fund.