Article Highlights: IRS Enforcement Campaign Virtual Currency Valuation Transactions Character of the Gain or Loss Foreign Currency Transactions Foreign Bank and Financial Account (FBAR) Reporting Payment for Goods and Services Acquiring Virtual Currency Virtual Currency Mining Employee Payments Independent Contractor Payments 1031 Exchanges The IRS announced in late July 2019 that it is ramping up its campaign to ensure that taxpayers with cryptocurrency transactions report these transactions on their income tax returns – and report them correctly – by sending “educational” letters to approximately 10,000 taxpayers who either didn’t report their crypto-transactions or may have reported them incorrectly. The IRS said it used its compliance efforts to identify the taxpayers who may be noncompliant. Because fewer than 900 taxpayers reported virtual currency gains and losses each year on their tax returns from 2013 to 2015, the IRS stepped up enforcement of the rules. As part of that effort, the IRS got court approval in March 2018 for a summons to obtain account and transaction information on more than 14,000 customers from Coinbase, a company that services buyers and sellers of Bitcoin. Although the IRS didn’t say so in its recent announcement, presumably the leads for the 10,000 taxpayers who will receive a letter came from this source. Taxpayers receiving these letters should not ignore them, as taxpayers who don’t properly report the income-tax consequences of virtual-currency transactions will be liable for not just the tax but also penalties and interest. In some cases, taxpayers could be subject to criminal prosecution. It may be necessary for taxpayers with cryptocurrency transactions to file amended returns to correct their earlier filings or to file a late original return for any year when they filed no return. This holds true not just for the recipients of the IRS’s letters but for others who have a filing requirement related to their cryptocurrency transactions. So let’s go over the basics of cryptocurrencies and taxes: As our world has become more “digital,” it was only a matter of time before cryptocurrencies were developed. One of the first of these virtual currencies was Bitcoin, and the Bitcoin network came online in 2009. Since then, additional cryptocurrencies have been developed. Cryptocurrencies have a comparable value in real currency or take the place of real currency. These virtual currencies can be purchased with or exchanged into U.S. dollars, euros, and other real or virtual currencies. Valuation – A virtual currency’s value is based upon market value, i.e., what a willing buyer will pay a willing seller – much like trading in stocks. On July 27, 2019, when this article was written and according to Oanda (an online currency converter), a Bitcoin (BTC), one of the more popular virtual currencies, was worth $9,780, while one Bitcoin was worth $12,650 on July 10 and $3,436 six months earlier. So you can see that this is a very volatile market. It took several years for the IRS to come up with guidance on how to deal to transactions involving virtual currencies. It finally issued Notice 2014-21, determining that virtual currency is to be treated as property and that the general tax principles applicable to property transactions also apply to transactions using virtual currency. Therefore, it is extremely important for taxpayers who engage in cryptocurrency transactions to maintain a record of their cost basis; this can be a daunting but necessary task for those actively buying and selling cryptocurrencies. How the property principles work for cryptocurrency can best be illustrated by example. Example A: A taxpayer buys Bitcoins (BTC) to use when making online purchases without the need for a credit card. He buys one BTC for $2,425 and later uses it to buy goods (BTC was trading at $2,500 at the time he made his purchase). He has a $75 ($2,500 − $2,425) reportable capital gain. This is the same result as if he had sold the BTC at the time of the purchase and used U.S. dollars to purchase the goods. This example points to the complicated record-keeping requirement for tracking BTC’s basis. Since this transaction was personal in nature, no loss would be allowed if the value of one BTC had been less than $2,425 at the time when the goods were purchased. Example B: Taxpayer buys Bitcoin (BTC) as an investment. The same rules apply as for stock transactions. Gains are taxable in the year realized, and any resulting loss, when combined with the other capital transactions for the year, are limited to $3,000 ($1,500 if a married taxpayer filing separate). At the same time that the IRS announced it was mailing 10,000 educational letters, it stated that it anticipates issuing additional legal guidance in this area in the near future.