When it comes to cryptocurrencies and taxation, it's all a matter of perspective. From the position of the regulatory authorities at the Internal Revenue Service (IRS), cryptocurrency investors should not be permitted to get away without paying taxes on their investments.
From the perspective of the investors themselves, though, it may seem that the IRS has overstepped its bounds. That feeling is likely to have only increased with the recent news that the IRS will require that cryptocurrency investors pay taxes beyond those required when they cash out their digital holdings for fiat currencies. The IRS has gone a step further, indicating that any items purchased using a digital currency could be taxable as capital gains, including the purchase of other digital currencies.
According to bitcoin.com, many taxpayers are likely to be unaware that when they use bitcoin (BTC) to purchase other digital currencies, as is commonly the practice for many leading exchanges, these transactions themselves become taxable. A tax accountant at the online tax filing service Visor explained that this "often catches people off guard, but once you break it out you've sold one coin and invested in another. That's one bear trap" set by the IRS for cryptocurrency investors.
Other Taxable Purchases
Beyond cryptocurrency-to-cryptocurrency purchases, which are typically relegated to digital exchanges, the use of a digital currency to buy physical items is also taxable in the same way. That is to say, physical purchases made in this way are not subjected to standard sales tax. The reason for this is that digital currencies are considered to be property in and of themselves. Perez adds that "under accounting rules, you have property that you exchanged for something else. People think because they've paid a sales tax so that's the end of the story. But it's not. We're talking about a property denominated in dollars. If you exchange that then there's a tax liability."
The entire situation is made all the more complicated because digital currency brokers are not required by law to issue 1099 forms. Individuals must calculate and report their profits on their own or else run the risk of facing tax evasion charges.
Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns bitcoin and ripple.