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Bitcoin investors beware: The IRS wants its piece of the action

Key Points
  • With bitcoin down more than 50 percent so far this year, there's a chance some investors have triggered (or will trigger) a tax loss by either selling, trading or spending it.
  • If you had gains in the past that you didn't report, you can amend affected tax returns.
  • The IRS found that from 2013 to 2015, only about 800 taxpayers claimed bitcoin gains in each year.
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If you didn't tell the IRS about your gains from bitcoin or other cryptocurrencies in the past, you might regret it this year.

With bitcoin down more than 50 percent so far in 2018, there's a chance some investors have triggered (or will trigger) a tax loss this year by either selling, trading or spending their digital assets. And while those losses can be used to offset any other investment gains, it could raise eyebrows at the IRS if it's the first time the agency is hearing about your crypto holdings.

"If I were in those shoes, I'd think about my past transactions and whether there were gains," said Sarah-Jane Morin, a partner in the San Francisco office of national law firm Morgan Lewis & Bockius.

"If I had gains, and I was not willing to go back and amend my return, I might not do anything that would trigger a loss," she said. "But you should just be reporting it correctly so you're not playing audit lottery."

The IRS has made it clear over the last few years that bitcoin and the other 1,500-plus digital assets are on its radar. Earlier this year, the agency released a notice to remind taxpayers that crypto transactions come with tax implications.

Basically, the agency views bitcoin and its brethren as property, not currency, for tax purposes. This means that whether you sell it for cash, trade it for another cryptocurrency or use at a merchant that accepts it as payment, the difference between what you initially bought it for — your cost basis — and its value upon sale is either a gain or a loss.

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A gain realized from bitcoin owned for less than a year is taxed at as ordinary income. Gains from bitcoin held longer is taxed as long-term gains. Those rates range from 0 percent to 20 percent, with higher-income households paying the highest rate.

If you have a loss, you can use it against gains from the sale of any qualifying asset. And if you have more in losses than gains, you can use up to $3,000 to offset ordinary income in that year and carry over the rest of the loss to future years.

In an examination of tax returns from 2013 to 2015, the IRS found that in each year only about 800 taxpayers claimed bitcoin gains. During that time, the price of one coin rose to $430, from about $13.

Last year, bitcoin investors would have been more likely to have gains than losses. The coin rose during 2017 to reach a trading high of more than $19,300 in late December after opening the year below $1,000.

Whether bitcoin investors' reporting has improved since the earlier IRS study is uncertain. CNBC requested 2017 data from the agency but did not hear back by publication time.

Meanwhile, since its 2014 guidance on the tax treatment of cryptocurrencies, the IRS has not issued further input. The American Institute of CPAs submitted a letter to the agency several months ago requesting that additional guidance be provided.

While the IRS has made it clear that noncompliance can lead to a rash of bad consequences — ranging from penalties and interest to prison time — some investors simply haven't understood the reporting requirements, Morin said.

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"A lot of people treat bitcoin as cash, or the same as [mobile payment service] Apple Pay," Morin said. "If they exchange it for another cryptocurrency or use it at, say, Overstock.com, they'd have to compare the fair market value of it that day versus their cost basis. They're not always tracking that kind of information."

She said that when those bitcoin holders go to do their tax returns, they have no idea what their gain or loss was, so they either don't report it or they try to cobble together information that may or may not be 100 percent accurate.

"In my view, the IRS would rather see some compliance made with your best effort instead of just throwing up your hands and saying it's too hard," Morin said.

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For many investments, individuals generally receive a Form 1099 that shows their taxable gains. The form also is sent to the IRS, which gives the agency a way to identify any differences in what's reported between brokerages and taxpayers.

Even if you get no official notice of your taxable gains, you're expected to report them. And the IRS has put the crypto world on notice: Earlier this year, the popular trading platform Coinbase alerted 13,000 customers that it was complying with a court order to provide the IRS with information on accounts worth at least $20,000 during 2013 to 2015.

"I think now is the time to try to get ahead of these issues, although it's going to be challenging for a lot of folks to go back and figure out what their cost basis was," Morin said.

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