United States: Tax And Cryptocurrencies

The meteoric rise of cryptocurrencies has created a stir in the financial and investment communities.1 The Securities and Exchange Commission, along with other regulatory bodies, is taking an active role in policing and regulating this sphere. However, while cryptocurrencies raise myriad tax issues, some of which are discussed in this article, the Internal Revenue Service (the IRS) has issued only minimal guidance in the area.

Cryptocurrency is a decentralized digital cash system based on blockchain technology. New coins are typically "mined" by solving complex mathematical equations. Some of the more well-known currencies include bitcoin, Ethereum and Ripple. Cryptocurrencies are increasingly used as currency for purchases. For example, Overstock.com and Expedia accept payment with certain cryptocurrencies. Cryptocurrencies are not backed by any hard currency but can be converted to other currencies on certain trading platforms.

Cryptocurrencies are similar to other currencies in many ways because they are mostly used as a medium of exchange and a way to pay for goods and services. However, because cryptocurrencies lack a centralized governmental authority that issues and regulates them, it may not be appropriate to treat cryptocurrencies as currencies for tax purposes. An alternative way to view cryptocurrencies would be to treat them as property.

The IRS position

In Notice 2014-21 (the Notice), which was issued in 2014 and is the only cryptocurrency guidance from the IRS thus far, the IRS adopted the property model. Under that approach, use of cryptocurrency in a purchase or an exchange for another cryptocurrency is akin to a barter exchange. Similarly, the conversion of a cryptocurrency to dollars is treated as a sale of the cryptocurrency. All such transactions are taxable events in which gain or loss is recognized by the taxpayer exchanging the cryptocurrency. According to the Notice, the character of such gain or loss depends on whether the cryptocurrency is a capital asset in the taxpayer's hands. The Notice also states that taxpayers who mine virtual currency realize income on the date of the receipt of cryptocurrency. Furthermore, taxpayers engaged in the trade or business of mining (but not as employees), receive ordinary income subject to self-employment tax when a coin is mined. Any payments in virtual currency are subject to information reporting and backup withholding.

The balance of this article follows the IRS position that cryptocurrency is property for income tax purposes.


A taxpayer's basis in cryptocurrency generally is the cost (or, if acquired in exchange for other cryptocurrency or property, the fair market value) on the date of acquisition. Taxpayers should keep track of their basis and holding period in each specific unit of cryptocurrency acquired. When a taxpayer holds multiple lots of a cryptocurrency with different tax bases and sells only a portion of its position, when computing gain or loss from the sale it would be optimal for the taxpayer to be able to identify the specific lot that was sold (e.g., the lot with the highest tax basis). Absent specific identification, the IRS employs a first-in first-out (FIFO) system, which generally would result in the sale of low-basis lots in a climbing market. Because each crypto coin is coded and thus unique, arguably they are not fungible and thus specific identification should be available (much like if a taxpayers sold one of two chairs that it owns with different bases). However, as a practical matter, when such coins are held in a third-party wallet, it might not be possible for the taxpayer to establish which lot was sold. Thus, while Treasury regulations permit specific identification with respect to the sale of stocks, it is unclear that taxpayers may use such method in the cryptocurrency space.


The taxability of cryptocurrency transactions, such as trades of cryptocurrencies and the use of cryptocurrencies as a means of payment, raises difficult valuation issues. In order to determine the amount of gain or loss, the taxpayer must determine the fair market value of the cryptocurrency at the time of the relevant transaction. For some of the smaller or lesser-known cryptocurrencies, there might not be a sufficient market or trading volume for a taxpayer to be able to accurately determine the value of the cryptocurrency at any given time. While websites are available for the more well-known cryptocurrencies to keep track of values, such valuations may differ dramatically on any given day or at any time. Furthermore, because public trading platforms for virtual currencies are often open at all times, there is also no daily opening or closing price that a taxpayer can point to as the value to use in a transaction.

Hard forks

A hard fork in cryptocurrency occurs when the cryptocurrency is split into two or more currencies. An example is the split of bitcoin in August 2017 into bitcoin and bitcoin cash. In the fork, each bitcoin was split into one bitcoin and one bitcoin cash. After the fork, bitcoin and bitcoin cash have traded separately.

The treatment of a hard fork for tax purposes depends on whether the hard fork is a taxable realization event. Moreover, if it is a realization event, the timing and the amount of the taxable income must be determined.

One could argue that a hard fork should not be a realization event because the taxpayer, generally, has no control over and possibly no knowledge of the fork beforehand. Moreover, there is no accretion of wealth (the general test of income), because what the taxpayer held was simply split in two. Whether it is appropriate to impose a tax on a taxpayer in this circumstance is, at least in part, a policy question without a clear answer.

If a hard fork is not a realization event, the taxpayer does not recognize any taxable income upon receipt of the new cryptocurrency. However, it is unclear what basis the taxpayer should take in either or both cryptocurrencies. One possibility is that a taxpayer must split its pre-fork basis among the new cryptocurrencies received in the hard fork based on their relative fair market values. Alternatively, the taxpayer may retain the basis in the original cryptocurrency (e.g., the bitcoin retained in the bitcoin hard fork) and take a zero basis in the new cryptocurrency received (e.g., the bitcoin cash).

If a hard fork is treated as a realization event, on the premise that there has been an exchange that gave rise to accretion of wealth, it is not clear how to measure the gain. One approach would be to include in income the fair market value of the new cryptocurrency received (e.g., the bitcoin cash) without any offset for a portion of the taxpayer's pre-fork basis. Another approach might be that the taxpayer must recognize gain or loss based on the difference between the fair market values of both cryptocurrencies received in the hard fork over the taxpayer's pre-fork basis.


Administering and policing the reporting of cryptocurrency transactions are difficult for the IRS because of the ingrained anonymity of cryptocurrencies. The IRS has begun spending more resources on training staff on virtual currencies and dedicating some of its enforcement agents to virtual currency. Thus, enforcement and auditing for underreporting of cryptocurrency income appear to be a growing focus for the IRS.

For example, in the pending case United States v. Coinbase Inc., No. 3:17-cv-01431 (2017-98027) (N.D. Cal. Nov. 28, 2017), the IRS has issued a John Doe summons to Coinbase, a digital wallet platform. After rounds of negotiation, Coinbase has been ordered to turn over to the IRS information regarding users that have engaged in at least one transaction (buy, sell, send or receive) with a value of at least $20,000 during 2013-2015 for which Coinbase had not filed a Form 1099-K. (A Form 1099-K is used to report payments made in settlement of reportable transactions.) The IRS undoubtedly will use such information to seek out taxpayers who have not reported their cryptocurrency transactions.

This article touches on only some of the myriad tax issues involving cryptocurrencies. As cryptocurrencies develop and more guidance becomes available, the analysis of the tax consequences of such transactions undoubtedly will evolve as well.


1 Terms such as "cryptocurrency," "digital currency" and "virtual currency" are used interchangeably throughout this article.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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