Finance, Industry, Opinion

Cryptocurrency Trading Will Be Taxed in 2018 in US

On December 22, US President Donald Trump signed the Tax Cuts and Jobs Act of 2017 (TCJA) into law. Many American traders and investors are happy about the tax reform’s reduction of corporate, pass-through business, and individual income tax rates. However, cryptocurrency traders and investors in particular are upset about an obscure change in the federal tax code. The TCJA removes Section 1031 exchanges for cryptocurrency, making all cryptocurrency trades taxable events. The tax code change will hurt profits and create an accounting challenge for crypto enthusiasts.

In the US, buying and selling securities and property are subject to capital gains tax. Sales of property and securities held for over a year are subject to a lower long-term capitals gains rate. Since 2014, 1031 “like exchanges” allows individuals to swap similar assets for each other without triggering a taxable event. 1031 exchanges are most notably used by real estate investors, but from 2018 onward, only real property will be eligible for 1031 exchanges. Before the TCJA, trades of one cryptocurrency for another would have deferred capital gains tax due to a 1031 exchange until the cryptocurrency was traded for a fiat currency. The TCJA eliminates the deferral, meaning that cryptocurrency trades will be taxable, likely forcing traders and investors to pay more capital gains tax at the short-term rate, equal to ordinary income rates.

Imagine a typical American crypto enthusiast who invests for the long-term. She decides to invest in a diversified portfolio of the ten largest cryptocurrencies weighted by market capitalization. She creates a few exchange accounts to buy Bitcoin (BTC), Ripple (XRP), Ethereum (ETH), Bitcoin Cash (BCH), Cardano (ADA), Litecoin (LTC), Stellar (XLM), IOTA (MIOTA), NEM (XEM), and DASH (DASH). Since cryptocurrencies like XRP cannot currently be bought with US dollars directly, she must first buy BTC or ETH in order to buy them on another exchange. In the past, tax would be deferred on the purchase until she sells the crypto for dollars. In 2018, she owes short-term capital gains tax on the sale of BTC or ETH for XRP. If she decides to trade XRP, then she owes tax on the sale of XRP for BTC or ETH. As since she likely does not wait a year to sell BTC or ETH and buy XRP, the capital gains tax will be at her ordinary income rates, theoretically up to twice as high depending on tax bracket.

Because it is easier for crypto investors than equity investors to day trade frequently due to 24/7 markets and lower commission fees, the TCJA will create a headache for active crypto investors. Crypto exchanges are relatively new and untested, so they generally pass the hassle of tax accounting to customers. Instead of offering a consolidated statement of gains and losses at year’s end like a traditional brokerage, crypto exchanges usually only have a record of trades. Thus crypto investors and accountants will probably spend more time and money on tax accounting in 2018.

The simplest way to solve the problem is to repeal the Section 1031 change. But the crypto community does not have a powerful lobby in Washington, so legislative reform is unlikely. Investors can petition the most successful exchanges to keep detailed tax accounting. Perhaps investors will turn to long-term buying-and-holding to escape the bite of short-term capital gains tax. Or perhaps investors will take a gamble and not report altcoin trading gains. Regardless of investors’ inclinations, the TCJA will definitely change the calculus of crypto investing in the new year.

The author holds a long position in BTC.