Mainstream Crypto Adoption: A Possible Tax Nightmare

The cryptocurrency space is filled with people who want mainstream adoption, but they often fail to realize just how difficult it would be to use bitcoin (or any other cryptocurrency) as a method of everyday payment while complying with current tax laws. Taking into account current regulations, tax expectations and cryptocurrency usage, mainstream crypto adoption turns into a giant headache.

Mainstream Crypto In Reality

The outlook on the future of cryptocurrency as a whole seems positive in terms of potential. Cryptocurrency adoption, however, requires changes to current regulatory framework to accommodate a new payment type.

To the general public, cryptocurrency adoption would not look much different than today’s fiat currency usage such as USD, EUR, etc. For example, businesses such as grocery stores and malls probably would use payment cards, but these cards would access crypto holdings rather than bank information. An article from CoinSutra mentioned cards such as Wirex or Cryptopay, which work like debit cards except they access cryptocurrency holdings. Buyers can use these cards anywhere that accepts debit or credit cards. All the crypto-to-fiat conversion is done on the backend by the card providers, as CoinDesk described in its guide on the subject.

Also, when purchasing products online, customers simply would send crypto assets (such as bitcoin, litecoin or bitcoin cash) to online stores’ crypto wallet addresses.

On a surface level, mainstream cryptocurrency use seems simple. Current regulation, however, complicates the situation. Cryptocurrency tax laws are complex, even regarding simple investments.

Classifying cryptocurrency trades or exchanges as like-kind exchanges might be a manageable, yet controversial, future solution. The Internal Revenue Service (IRS) mentioned this topic under IRC Code Section 1031.

Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.”

Like-kind exchanges for crypto would mean allowing taxable events to occur only when selling crypto for fiat. This means that buying ethereum with bitcoin would not trigger a taxable event until the ethereum was sold into fiat. Put simply, taxation would occur on whatever gain or loss was incurred when the crypto asset was sold for fiat, based on how much USD was originally invested.

That being said, Cross Law Group explained the like-kind model might not be applicable under current regulation.

The bottom line is that crypto-to-crypto trades can technically qualify as like-kind exchanges, but such qualification is uncertain at best.”

Implementing like-kind exchanges also may not be the easiest solution. Like-kind exchanges may be simpler in the short-term, but, once people trade crypto into fiat or make purchases, it can be difficult to evaluate and track gains when only a fraction of the original cost basis is sold into fiat.

A Student’s Crypto Tax Struggle

November 2018 saw a Reddit post from a distressed college student on the topic of crypto-related taxation. The student invested $5,000 into the crypto markets at the beginning of 2017. Through trading and investing, the student turned that $5,000 into $880,000 by the end of 2017.

Due to 2018’s crypto bear market, the student’s portfolio valued only $125,000 at the time of his Reddit post. He said he still owed $400,000 in taxes for his taxable crypto-to-crypto trading events in 2017, even though he claimed he never sold his portfolio into fiat.

Why Are Crypto Taxes So Confusing?

Tracking and recording these events is difficult. For example, a fictional crypto user used Coinbase to buy litecoin with USD. He bought one litecoin for $30. Two days later, litecoin’s price went up to $40. The user then used that litecoin to buy 133 0x tokens at $0.30 each. He just triggered a taxable event buying 0x with litecoin.

For that one trade (buying 0x with litecoin), the mentioned crypto user would need to record the USD price of litecoin at the time of the 0x purchase, the USD price of 0x at the time of purchase, and the amount of litecoin spent to buy the end amount of 0x. Then he or his accountant would need to calculate his net gain or loss on that event (trade).

Coinbase keeps great records of transactions and trades for each customer, but the majority of exchanges don’t. Complications deepen when crypto users store their funds in cold storage wallets or wallets such as Exodus that can swap crypto assets for users.

In addition, the majority of cryptocurrencies can only be bought with bitcoin. If anyone wanted to buy any other cryptocurrency, he would need to buy bitcoin with fiat, send bitcoin from Coinbase to an exchange that trades the desired cryptocurrency and then buy that asset with bitcoin there. He would then need to record all the amounts, prices and other applicable data during the process of those trades.

The process becomes more complicated when buying products with cryptocurrency. In another hypothetical example, a fictional crypto trader wanted to buy a $25 hat on Amazon, paid via litecoin (assuming Amazon accepts litecoin). He would likely hold several litecoin stored somewhere, ready to use as payment.

The crypto user bought the hat for $25. He then needed to account for sales tax on that item. Tax in this example was $5 on a $25 purchase. The ending payment amount was $30 for the hat, transacted with one litecoin at $30 (including tax). He would, however, also need to account for all the previous gain or loss up to that point.

How much total USD did he originally use to buy that litecoin? How many litecoin did he buy? When did he buy it? What was litecoin’s individual price when he first bought it? What was the price of litecoin when he bought the hat? How much gain did he have from when he bought litecoin with USD to when he used it to pay for the hat?

The purchased hat was just one example of a single purchase, and even the most basic examples are complicated. Imagine if a crypto holder used 0.005 bitcoin to fill his car with $20 of gas. Or bought a donut for $2.75 with 0.083 litecoin, factoring in all of the above. Imagine dealing with five general purchases per day. Services such as Cointracking help track trades, gains and losses associated with crypto exchanges and holdings. There are also other services that track and record transactions, trades, etc.

Although crypto can be sent to many different wallet addresses, storage types and locations, complicating such services. There are a bevy of different aspects to consider. Each of these services also often cost money, in addition to paying an accountant to sort through it all. The main point is that under current tax laws, daily cryptocurrency payment would seemingly put users at risk for audits.

CoinDesk recently reported on a Japanese lawmaker who recommended four regulatory changes to improve Japan’s difficult crypto tax situation. The four proposed changes included tax exemptions for crypto-to-crypto trades.

In cryptocurrency, every transaction is recorded on an online public ledger. It is possible to develop the necessary tools to make this process easy. Although, currently, the world may not be ready for daily crypto payments, given tax laws stay the same.

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