How Do Governments Tax Bitcoin? | Crypto Tax Accountant on Like-Kind Exchange and Other Loopholes



what's up everybody welcome to this week's crypto forces segment of the hidden forces podcast where as people engineers investors entrepreneurs and anyone else from the world of crypto currencies and distributed consensus today I speak with Marc de Michael a forensic accountant with Citrin Cooperman who specializes in the tax implications for crypto currencies we're going to talk about taxable events like kind exchange and what the filing requirements are for anyone who is profited from transacted in or mind a cryptocurrency at any point in the last nine years this is an incredibly informative and timely discussion so let's get right to it mark welcome to hidden forces Thank You Dimitri it's great having you on man definitely glad to be here do you remember when you and I first met I believe it was about a month and a half ago at one of those crypto circle networking right Richie hecklers crypto currency working group oh right correct yeah yeah the group was founded with Richie and he did it at Goldman Sachs with Goldman and it was like a group of like 20 people and there was someone from hash Grethe so that's how I came across hash graph but we met at and room asantos apartment where they were like a hundred people or something and I overheard you talking a couple of guys who were trying to ask you like what they're supposed to do with crypto currencies and taxes and stuff like that and they were specifically talking about like-kind exchange because they're talking about like if I had some Bitcoin and I you know I bought some IC o—- I did I bought it in an IC o—- and I got a different cryptocurrency do I have to pay and you were responding and you were something like you really knew your and I was like this guy really knows his on taxes I haven't heard anyone talk about taxes I got to pick this guy's brain so I picked your brain turns out you're also a nice guy and I thought it would be great to have you on because I haven't been able to find anyone or anything any real source to talk about taxes so I want to sort this out with you a little bit right definitely now you as I mentioned the audience you you're sort of an autodidact on this your tactic you are an accountant but you're your friends ik accountant but you specialize in taxes among other things right well I originally I was a fraud and forensic accountant that was how I got into this to begin with you know back in the day this is mainstream now but back in the day this was you know underground criminal fraud type stuff cryptocurrency crypto currencies yeah so that's when I first became interested in it wanted to learn more about it and that's why I'm a good bit ahead of the curve compared to most accountants I don't know that I spoke with this story when so when did you start looking into this when did you start doing this as part of your friends at work well I haven't had any forensic cases dealing with it yet I'm sure it's once coming down the pipe I'm sure but it was just staying current in the field I knew this was this was where it was at as far as you know fraud and money laundering I wanted to stay current so I began learning about this what did you tell me and I I didn't educate myself properly on this you sent me an article but if there's some dispute as to whether or not money laundering is what is this there was actually a Florida Court that ruled about a year and I believe it was about a year and a half ago that Bitcoin was not money so it couldn't be laundered and they had a guy in Florida we're trying this guy for money laundering and the judge basically threw the case out Florida subsequently passed legislation saying for purposes of money this stuff happens that's so funny so let me ask you something that's so funny let me ask you something are you telling me that back then if I had a million dollars and I turn it into Bitcoin and I moved it from here to Colombia and I turned into cash there that I wouldn't have been able to get prosecuted for money laundering but I could have gotten prosecuted for tax evasion well there's different and that was a Florida Court different jurisdictions might feel differently about if it was in Florida let's say but if it was in Florida arguably you could have been that guy who got away with but I would have been charged for tax evasion oh absolutely I mean tax evasion is because there would have been some small gain potentially speaking if there was a gain when I went and laundered the money if the currency increased in value when I cashed out on it right well you could have gotten the money illegally and still paid taxes on it and then laundered it and then you would not be guilty of tax evasion but most criminals tend not to pay taxes right let's hope put in money well that's the whole point of being a criminal oh yeah so so let's talk a little bit about this how many people have reported you do you do we know how many people reported gains for cryptocurrencies I assume primarily Bitcoin in the last five years so we don't know for sure but the IRS did make a claim in a court pleading against coinbase where they were trying to get their hands on some point based records but they said in that pleading that only 800 to 900 people paid gains on cryptocurrency between 2013 and 2015 mm-hmm that relates to about 14,000 people who had sold over 20,000 dollars worth of cryptocurrency just on a point base just on coins 800 people had paid taxes across the entire universe of cryptocurrencies within the United States or just coinbase users across the United States total according to the IRS do we know what percentage of transactions or Bitcoin is stored on coinbase for all Americans I don't believe we have that data but it's the pseudo anonymous nature of this right there's no way to come up with those at least currently as far as I can tell no one has come up with those types of statistics except for there is that company was that chain analysis or something where you get into that because that the IRS is using that company to try and figure out sort of who owns what and everything else which is interesting and I want to talk to you about that all right so I mean clearly a very small number of people have reported taxes on Bitcoin and cryptocurrencies and the estimate is that there are many many many many many people who have realized gains and of cryptocurrency but haven't paid taxes either out of negligence either out of just not knowing or whatever there could be a gazillion reasons why so let's I want to do this I want to have this conversation I should have said this in the beginning is because I want to give the audience the most information possible is something that I think is really important because whether you agree with being taxed on this or not and I actually think there's some really ridiculous ideas around taxing people for gains in Bitcoin now we can get into some of the particulars that I think are most ridiculous just for fun but it doesn't matter at the other day you have to pay the IRS because if you don't there are consequences so what constitutes a taxable event in in the context of Bitcoin or in other Kryptonian if you purchase cryptocurrency that is not a taxable event it would be upon the sale of that cryptocurrency that would be the taxable of now that's what buys and sells it's a little different if you were to receive cryptocurrency for a service of some kind let's say you perform a service or sell goods and receive cryptocurrency for that that would be a taxable event in and of itself and they're handled a little bit differently it's a taxable event only if I if there's a gain in the underlying value of the currency that I'm transacting in order that I'm cashing out of right well let's say I performed accounting services for you hmm and you pay me in cryptocurrency my receipt of that cryptocurrency in and of itself even though I sold saying even though I haven't sold it is still income to me because I did work and I got paid so essentially I would have to value that cryptocurrency in u.s. dollars and that would be the amount that I would be required to report on my tax return so basically whether I'm cashing out whether I'm buying Bitcoin as a speculation for an appreciating value and I see it as an asset or whether I've actually used it in transactions which is less likely today because of the size of Bitcoin most people tend to be for that particular cryptocurrency I think this is also interesting right because this brings us into a question about the difference between different types of tokens right like if you have a utility token like an aetherium where you're you're using it as part of like a fuel that kind of really puts an enormous burden on the network in terms of having to account for whatever value that token is at any moment in time it dampens the utility value of that token doesn't it well correct the way the tax laws are currently set up having to report every single transaction either a gain or a loss is extremely burdensome from a reporting requirement right it takes a lot of work and it takes a lot of record-keeping there's some potential for that to change at some point in the future but as of right now that is a big impediment to global acceptance of quick release in the United States acceptance of cryptocurrency and using it for regular transactions that's not something that I've heard people talk about and I think it's huge right like so I know about this a bit just from the precious metals market and you know a lot of people assume that the legal tender laws are what prohibit or make it difficult for people to transact in a non-us based currency but in fact it's the IRS and fact it's actually having to pay taxes you have to pay taxes in dollars and I think it's even heightened more so with utility tokens because if you're gonna build a network where you're transacting in an underlined you need something that's an underlying piece of fuel and you need to actually account for the appreciation of that I mean in the United States if you're transacting a dollars and the dollars is in a bull market a multi-year bull market let's say and the dollar index is up 20% year-over-year you don't need to pay taxes on that 20% rise in the US dollar because you're living in the United States dollars the whole time exactly so it's just an interesting thing and I wonder you know it's something that I've never thought about until you brought it up to me and it makes me wonder really how to work all these things that we're talking about again this is like a really specific example of how the regulatory dilemma is really problematic and much more so I think for a company like etherium or for a protocol for a distributed consensus network like etherium than it is for Bitcoin where it's a very simple kind of asset appreciation and you're buying and holding and selling one transaction at a time exactly but it really limits the case for using for the utility of the underlying currency talk to me a little bit about like kind exchange I mentioned that in the beginning when I mentioned how I heard you how I met you and I was hearing you talk with a couple of Wall Street guys about this what is a like-kind exchange a 1031 exchange and how is that relevant to this conversation around taxable events because many people I think even people and artists will have heard about this yes so a like-kind exchange is a exchange of one type of property for another and the two types of property need to be of what's called like-kind they need to be similar and there's been some case law on that historically normally this is related to real estate and generally only real estate but there's been a few other types of transactions that have occurred so a like-kind exchange is a an exchange of one piece of property for another if you exchange one piece of property for another normally that would be a taxable event the like-kind exchange or a 1031 exchange because it's IRS section 1031 allows you to defer recognition of that taxable event so let's say I buy a piece of real estate for a million dollars I trade it for another piece of real estate and when they're both worth say five million instead of me reporting a four million dollar gain if I file the paperwork correctly I can defer that gain and pay it at some point down the road when I sell my new piece of real estate essentially what it allows you it basically sees the two pieces of real estate is the same you're able to make a transaction trading one piece for another basically in your portfolio and you can defer having to pay the taxes later on yes so there's three relevant issues this is going away in 2018 there's only question mark does that have to be in the same market like for example does it have to be like if I'm selling a piece of real estate in Miami there's one piece need to be on South beaches the other pieces need to be on South Beach no so I could sell my South Beach property and buy something in Idaho correct only caveat with that is you're not allowed to get it's called constructive receipt of the funds so if you sell your property get money and then buy a new piece of property that's no good what you'd have to normally do is use some kind of an escrow agent to keep that money out of your hands that's interesting though because there is a big difference there because you are and I'll make my point as to why I'm thinking about that but really I mean if I think that because real estate is local so South Beach real estate is not the same thing as real estate in Idaho and if I'm gonna be doing that I mean that could be very unrighteous to me as a real estate buyer and seller which you could easily make the argument for someone who's let's say trading aetherium for Bitcoin right so with regards to real estate you're right it's a fair point you know maybe a piece of real estate in Idaho is not like a piece of real estate on South Beach but for purposes of the tax law and the way this is going so far the government is going to accept to any pretty much any two pieces of real estate with regard to cryptocurrency it's kind of unsettled Real Estate's a little different there's a lot of case law on real estate but with regards to like kind exchanges for other types of assets it's kind of limited they're not that common what we do have some regulation on is precious metal exchanges and I think that is probably the closest proxy to cryptocurrency when if you're gonna look at you know past case law and revenue rulings there was a court case in the ninth District of California where they found that gold coins traded for gold coins did not count as a like-kind exchange because both of those coins were collectors items you know the two coins in question one were Swiss francs old Swiss francs back when they used to be made of gold and some other type of gold coins they were rare items and they were priced based on their rarity right whereas in other types of cases the IRS has said in Revenue Ruling 76-14 that an exchange of 50 Mexican peso gold bullion coins for Austrian Corona gold coins did qualify as a like-kind exchange because those types of coins are simply valued based on their metal content so it's your trading basically raw gold for raw gold right even though it's in the shape of a coin right well I was saying to you when you told me this I mean I could see first of all it makes sense the numismatic value difference I mean if I have if I found gold from Columbus's ship one gold coin one ounce of gold from Columbus a ship that's obviously gonna be worth a ton more than some melted ounce of gold I understand that but I also think it's interesting to point out that it's also true that thousand ounces of gold coins is worth more than a gold bar because a gold bar is the same amount of gold but there's a utility value to being able to transport those coins I guess what my point is that I can see the nuance in each one of these then I just I'm pointing that out as we're talking so go ahead I'm sorry to interrupt okay so you know I've spoken with some other people about this and look there haven't been any tax rulings on this so we don't know for sure whether a cryptocurrency can qualify for a like-kind exchange at all or if they you know can very easily qualify but the way it looks like to me since the value of with reference to the gold example I gave what it comes down to is the nature and the character of that piece of property with regard to cryptocurrency here's the way I kind of see it if you were to trade Bitcoin for say Bitcoin cash those are very similar assets they you know a lot of their code is similar they are both pure crypto currencies they don't have any utility outside of you know being a crypto currency something you can trade as a medium of exchange that is more likely to qualify as a like-kind exchange then let's say a trade of Bitcoin for aetherium because as you know aetherium is a utility token mm-hmm atheria ms designed to be used as gas to basically run a transaction through the etherium blockchain so the value of aetherium is impacted by different factors than the value of a Bitcoin whereas the value of a Bitcoin and a value of Bitcoin cash are much more similar so it's safe to say that the more alike your cryptocurrencies are that you're trading one for another the more likely you would be to qualify for this deferred gain what about if I were holding a hundred bitcoins during the hard fork and then I got a hundred Bitcoin cash well that's a little different that's not it we're not in like kind exchange territory anymore but there's actually two competing schools of thought on that as well the first is is pretty simple the IRS says Bitcoin is property and it says that all cryptocurrencies are property you had one type of property and then was that you – was IRS notice 2014 – 21 okay they declared that any convertible virtual currency is to be treated as property and that's a lot of what I've been talking about today derives from that when was that unification it was March 25th of 2014 2014 so go ahead and interrupt you we're talking about the hard fork and the fact that you basically got a bunch of free Bitcoin cash that have since appreciated in value correct so one school of thought is that receiving the Bitcoin cash is almost as though you had mined that Bitcoin cash you just got a new piece of property and you have to pay taxes on that new piece of property right away so I forget the exact value of Bitcoin cash when it launched but let's say it was $250 and let's say you held for Bitcoin you were given for Bitcoin cash that would be a $1000 you only pay profits on what it was on the first trading day at the close of the first trading usual practice that's when you received it good nightmare honestly this is a nightmare no wonder you guys make so much money yeah so they have to help us you have to help go ahead so that would be when you received it was you pay taxes when you received it just like you mind it or just like you performed the service for so you are you saying that if I like take my metal detector because I was a big fan of like man I don't know do you have a metal detector growing up I did not I didn't actually have one but like my uncle had one and like we went once like you looking for like you know treasure right I had a whole thing I don't know where it came from I may be eighties movies yep but are you saying that if I took my metal detector and I started like going you know to the beach and I found like some gold coin and I found a thousand dollars that I have to pay taxes on that to the US government that's correct that's been crazy found property would be pretty nuts that's not intuitive even though I understand the logic it doesn't seem intuitive that I'd have to pay if I found $20 on the street that I have to pay taxes on $20 anyway legally speaking so go ahead I interrupt you again mark so that's one school of thought is that a you just received a nice piece of property I could dividend you need to pay taxes on it a little different than dividend because dividends can qualify for preferential tax treatment okay whereas cryptocurrency debate in my income tax bracket whatever it is I have to pay that correct yeah that's ordinary income on that date right basically the second school of thought is that this type of transaction this forked Bitcoin cash for example is kind of similar to let's say you're a farmer and you have a cow and your cow gives birth to a calf that is not and has never been considered attachable event so is Bitcoin cash more like finding a piece of gold buried on the beach somewhere with your metal detector or is it more like you know the Bitcoin gave birth that's pretty amazing so what that's really amazing that like farmers I guess it would take a lot I don't know what how long it would take to grow your stock your your farm stock but that's a pretty interesting idea that you can start with a certain number of calf and you can actually expand your asset base and not get taxed for it that's interested in right that's a whole thing I bet there's so many fascinating aspects of tax policy in the United States and so there are but there are all these incredible loopholes that when you know how to use them and exploit them it is a very very powerful tool definitely it can be interesting that's why so many people have managed me tons of money and pay very few taxes and the rest of us are paying up the ass for ya anyway so alright I'm going off the chains again but there's just something really fun about having you here mark alright so okay so you're saying with regard to that okay it's either it's a tax either it's property that you received or it's a calf that was born from your bigger bowl back bowl bulls don't give birth right from your cow in which case you'll have to pay taxes on it it's not clear you which raise taxes when you work as so but going back to the like on exchange to the 1031 what we do know though for sure is under the new tax bill they have restricted 1031 s to real estate assets only right correct the other important point to mention there is for a 1031 exchange you need to be holding that piece of property for investment purposes not for resale purposes and again this is another fuzzy area the IRS has said with regard to real estate if you hold a piece of real estate for over two years they will consider that to be for investment purposes at least two years it's probably safe to say that same two-year holding period would apply to Bitcoin if it's or any cryptocurrency if you're holding it for a shorter period of time it depends on the facts and circumstances of that particular case you know if you hold it more than a year that the longer you hold it the more likely it is to be an investment then being held for resale but if I bought something as an investment let's say I bought a piece of real estate for an investment and I was gonna hold it for a long time I intended to but then you come knock on my door and offer me a bundle of money for it I can have that you know that really big gain there that I can qualify for a 1031 if a court feels that in that circumstance I was holding it for investment purposes but I just decided to sell it early mm-hmm so it's very much a gray area so that's interesting and to clarify something going forward it's very clear that like-kind exchanges you don't qualify for like-kind exchange under any circumstances under any circumstance if you own or transact in any other cryptocurrencies but it's not clear whether retro actively or in you know prior to the passing of this new tax law that you qualify and that's that people would need to look at with their accountant correct they're the new tax law has not changed anything cuz you're right actually but you may actually qualify in other words you may actually qualify in the past for our like-kind exchange it's unclear and you should look into it correct like I said that you don't think so you don't think so you think it's unlikely I'd say it's probably unlikely yes but again the closer those two currencies are like say Bitcoin for Bitcoin cash that's more likely than Bitcoin for a theorem all right I want to ask you one more thing and it has to do with how the IRS is tracking and keeping up with who is transacting what and at what valuations you mentioned this one company called chain analysis and they they have a really interesting process for how they've been able to actually figure out who owns what right now you explained this to me but explain it again to me because I still unclear on it and it'll be helpful for my audience to understand as well yeah so it's known I've read in several articles that the IRS has a contract with its a company called chain alysus chain Allison analysis yeah one word and they've had that contract in place since 2015 and okay now unless this is a company that does basically big scale data analytics on block chains and I think they're probably mostly focusing on Bitcoin at this point because that's where the money is from a market cap standpoint but that seems to be changing on a daily basis but what Cain alysus does is they basically gather data on blockchain transactions and what they're able to do is they're able to sometimes link different accounts like for example if I'm holding bitcoins am holding five Bitcoin I could be holding those five Bitcoin in one account or I could have them spread out in several different Bitcoin addresses accounts probably were key there via the public address is correct let's say I'm holding my five Bitcoin in two different accounts and I send five Bitcoin to you those both accounts are gonna be inputs to one transaction and that transactions gonna have one output to you gain alysus looks for those types of transactions and once they see one of those they recognize okay these two accounts are linked they must be owned by the same person ID because they would need to have the same in order to make this transaction happen they basically just monitored the blockchain on an ongoing basis looking to form those types of relation solid ating wallet figure about all the different accounts that you have and they're figuring out you know what the one person is that has all those accounts correct which makes up the accounting process a lot easier they're also linking many transactions to known Bitcoin exchange account so if coinbase if I want to send some money to coinbase and they give me a address to send it to that's known now that that address is a coin base address so they're able to link that address to other addresses and you know even if you didn't exchange directly with an exchange you might be able to be linked to one through another person right like if I were to buy a Bitcoin on coin base and then sell it to you in a private transaction if the IRS were to come after me and let's say they were to catch me right in some type of tax evasion they could then try and get me to flip on you if you're a bigger fish and I kind of bring this up for one really big reason I mean one I'm just always interested in you know creative ways that people do things I think that's really interesting creative that they're doing this whether I I mean I wouldn't want them catching me good thing like I said to already and so that I haven't bought a single Bitcoin for other reasons but what I am most interested in pointing out is that this false narrative this idea that you can evade taxes through Bitcoin that a lot of people seem to think who don't own Bitcoin or don't transact in Bitcoin is completely false it actually the paper trail is probably makes it a lot easier to catch somebody which is what everyone says well what certain people you know point out so let me ask you one last question mark if people now people let's say we're getting near tax season what would you not advise people you know like is any accountant able to do this you know like are there certain accounts that are more qualified and also like how can people reach out to you if they have a question or something like that I'd say definitely you know I've talked to a lot of different accountants some know this understand it and some just don't as long as they're up to date and reading that that IRS Revenue Ruling this mark yeah it's not that many actually they're not really that many did I see just a handful of them at these uh networking events here and there but alright there's not that many so hun if you do want to reach out to me I can give my contact information yeah do that it's a two one two six nine seven one thousand and I'm at extension one three six nine do you want to give out your email to or something like that is there a way we can just post it on the website no no I'll do that I mean people listen not everyone goes to I mean hardly anyone goes to the website Bao all right then let's we'll keep it on the phone as I say and you're a great guy which is why I actually won not only you're smart and you know you're into this stuff but you are really good person if I did have anyone doing my taxes I feel very comfortable with you doing it so I appreciate you coming on and I hope our audience has learned something important from this very hazy and emotional subject great thanks for having me alright then forget it and that was my episode with Mark – Michael I want to thank Mark for being on my program today's episode was produced by me and edited by soo Yun de porão for more episodes you can check out our website at hidden forces pod com join the conversation through facebook twitter and instagram at hidden forces pod or send me an email @ DK at hidden forces pod calm thanks for listening we'll see you next week

2 thoughts on “How Do Governments Tax Bitcoin? | Crypto Tax Accountant on Like-Kind Exchange and Other Loopholes”

  1. Thanks! Great interview of a great guest. Tax is a fascinating subject, particularly the gaining of 'efficiencies' available through internationalizing. Easy for me but much harder for USA citizens than for any others – apart from Eritreans and North Koreans, but I think that worldwide taxation on citizens and resident aliens may be the least of their problems. 😉

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