Bitcoin has defied financial gravity in 2017 but, in one respect, it’s just like any other investment: Uncle Sam expects a cut of the profits when you sell it. And starting in 2018 it will get a little harder to avoid paying up.
That’s because the major tax reform passed in Congress this week contains a tweak that eliminates an exemption for many “like kind exchanges,” which lets people swap an asset for a similar one without triggering a tax obligation.
Until now, some investors have relied on the law to exchange one digital currency for another without paying taxes. For instance, someone who owned Bitcoin could diversify their holdings into Ethereum or Litecoin, and plausibly tell the IRS it created no tax obligations.
As Suzanne Walsh, a partner at the law firm Murtha Cullina, explained to Fortune, this is no longer the case because of a tweak to definition of property eligible for the exemption:
The tax act in Sec. 13303 amends IRC Section 1031 (a)(1) to delete “property” and replace it with “real property” … So, you can see that now I can no longer take the position that my Bitcoin to Litecoin exchange was a like kind one under Sec. 1031, and I have to recognize the gain when I do it.
Walsh added that the “in kind” exemption can now only apply to real estate transactions, effectively closing a loophole that has been open to other sort of property transaction such as those involving Bitcoin.
Digital currency owners are currently obliged to pay taxes when they exchange it for dollars or physical goods, but the new rule now effectively means all crypto transactions are a taxable event.
This doesn’t mean, of course, that everyone will heed the rule, especially as an IRS investigation revealed that only 802 customers of Coinbase, a popular digital currency exchange, filed a 8949 form related to Bitcoin-related activity in 2015.
For law-abiding investors, however, the process of reporting digital currency profits—which are taxed as ordinary income in the short term and as capital gains in the long term—will be arduous since Bitcoin exchanges have yet to provide customers with a 1099 form. These forms, which are used by brokerage firms like Fidelity, provide a summary of investment income and are given both to customers and the IRS.
Meanwhile, the tax headaches for digital currency investors are only going to increase as they must figure out how to account for spin-off currencies like Bitcoin Cash, and as the IRS deploys special software to identify Bitcoin tax cheats. While elected officials like Rep. Jared Polis (D-Co.) proposed an amendment to lighten the reporting requirements for digital currency, the measure did not get included in the final bill.
President Trump is expected to sign the major tax overhaul, which passed both houses of Congress this week, in the next few days.
