The Trump administration has just signed into law a new tax bill that is set to be a major overhaul to the U.S. tax regime.
There has been a lot of talks about how the tax bill is likely to impact different groups of people. One that is of particular interest to us is how the taxes will impact cryptocurrency traders.
In particular, the bill seems to amend section 1031 (a)(1) of the tax code. It will more narrowly define a particular loophole that was beneficial to crypto traders.
What Was the Loophole
The Loophole in question dealt with transactions that were termed “like kind exchanges” and were a popular one in the 1031 section.
This would allow investors to swap two similar assets without having the effect of triggering a “tax event”. They were used extensively for the exchange of assets like property and real estate.
Investors could exchange one piece of real estate for another and because they were considered of the same kind, they did not have to declare this to the IRS.
This was also a well-known loophole for cryptocurrency traders. This is because since 2014, the IRS has been treating digital assets as “property”.
Given that it was classified as such, any capital gains on it were taxed much like property. If they were held for less than a year and liquidated then they will be taxed as regular income.
Yet, according to the 1031 loophole, if they were exchanged for another coin it did not trigger a tax event. If a trader exchanged their Bitcoin for Ethereum for example, they would not trigger an event.
Too Many Triggers to Count
In the new tax bill, the section 1031 was rewritten to specifically define those assets which would be considered.
The wording has gone from covering general “property” to covering only “real property”. This means that only swaps that involve physical cryptocurrency can avoid the trigger.
As cryptocurrency is definitively not “real property”, every time you make a trade for another digital currency at a profit, you are triggering a tax event that requires reporting.
For those crypto traders who regularly trade among different coins, this is likely to be a nightmare from a reporting standpoint. Starting next year, you could be liable for tax on short term non fiat gains.
Impact on Crypto Trader
There is not just the additional administrative costs that a trader will now have to occur but also possibly increased tax rates.
Whereas before traders could defer liquidation of Crypto gains for one year, they could cash out and only pay 24% on the capital gains.
However, given that they now will have to pay tax on short term non-fiat gains, they will be paying tax on the “income”. This is taxed at a rate of between 10-37% depending on bracket.
The end result is that in order to avoid income tax rates, the trader would either have to just Hodl for a year without trading. This is unlikely as it defeats the purpose of “trading”.
Although these are the laws that have now been defined by the Tax bill, it remains to be seen how many cryptocurrency traders are likely to abide by it to the book.
They have not had a particularly strong record of declaring the profits that they have made on cryptocurrency investments. For example, from 2013-2015 fewer than 1,000 people declared their crypto gains.
This led to the recent court case between Coinbase and the IRS where the Taxman was asking for the user records of a number of trader accounts.
Knowing this, traders would be taking numerous risks by not declaring the gains that they have made on their crypto trading profits.
Although there is no exact guidance as to how this is definitively going to be treated or monitored by the IRS, the wording is indeed quite clear.
With all of the appreciation that has been seen in cryptocurrencies recently, there will no doubt be great demand for many lawyers and accountants from profitable traders.
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