Thursday, December 25, 2014

I am a tax attorney, here are my answers to common questions about bitcoin losses and the rule against wash sales. (self.Bitcoin)

Over at Reddit we came across the following discussion: 
all 60 comments
[–]dblcross121[S] 25 points  

Continued from Above

#13 How long should I wait to repurchase after selling my bitcoins for a loss? Unfortunately, there is no clear answer to this question. Traditionally, the amount of time required to pass in order for a transaction to gain "economic substance" depended on the volatility of the market. The more volatile, the less time was needed. And visa-versa.
It goes without saying that bitcoin is an extremely volatile asset, so we can probably safely assume that you do not need to wait very long. 30 days (which is the requirement under Section 1091 for wash sales of stocks and securities) is certainly long enough, but would essentially defeat the point. Conversely, waiting only a matter of minutes is almost as certainly not long enough.
So, where does the magic number lie? It's impossible to say for certain. One day is definitely on the low end and probably the shortest amount of time that you could conceivably get away with (but it would still be quite risky). I would tend to think something in the three to five day range is more appropriate, with a week or more being a safer choice for those who want to eliminate the risk of the economic substance doctrine as much as possible. At the end of the day, the decision is up to you -- just keep in mind that longer is better.
Example: Instead of immediately repurchasing the bitcoins he sold, Bob from the previous example waits five days to make the repurchase. In the mean time, the price of bitcoin fluctuates 5% each day, but ends up at almost the exact same price that he sold them. Bob repurchases the same amount of bitcoin at this price. If Bob were audited, he would have a strong argument that the transaction did not lack economic substance because he exposed himself to the market risk of bitcoin, regardless of the fact that he was able to repurchase at the same price five days later.
#14 Should I use wash sales to generate losses by the end of the year?
Maybe. Typically the strategy of "taking losses" is used to offset gains that you might've had on other investments during the year. In that case, using a wash sale to generate losses could help reduce your taxes considerably.
On the other hand, a wash sale essentially resets your cost basis and holding period. By that I mean you now own the bitcoin at the new purchase price and the new purchase date. So, you'll have to weigh the possibility of higher capital gains in the future, as well as the possibility of losing long-term status, against the current year tax savings.


At the end of the day, losses on bitcoins are treated just the same as losses on shares of stock, with one exception: the wash sale rules of Section 1091 do not apply. Regardless, a wash sale lacking economic substance can be invalidated by the IRS, so it's a good idea to wait at least a few of days before repurchasing.
I'll try to answer any questions, but keep in mind this is general information only and not legal advice.
[–]justanothershibehere 7 points  
Thank you so very much for this public service. Merry Christmas good sir.
[–]brovbro 3 points  
Really awesome of you to share such a lucid, thorough explanation of common Bitcoin related tax questions. Thanks man!
[–]Vlad2Vlad 2 points  
The $3,000 cap loss limit per year is against ordinary income, correct?
I didn't think that was stated very clearly.
So you deduct the Max cap losses for the year for all your cap gains and then if there are losses left over or carried over you can deduct an additional $3,000 cap loss against your ordinary income.
And you can do this every year until your cap loss carry-forward has been exhausted
This is how I understand it.

Thanks for your input, I learned some new stuff - like I didn't know crypto currencies qualified for the much lower long term cap gains rule which apply to stocks.

20% tax hit instead of 45% is awesome and worth holding for 12+ months.
[–]dblcross121[S] 2 points  
Correct, the $3,000 cap applies only to the net loss reported on your tax return (and therefore offsetting ordinary income).
[–]kiisfm 1 point  
What's unordinary?
[–]celedral 2 points  
Is it too late to sell?
[–]dblcross121[S] 3 points  
Nope. Losses have to be realized by the end of the year (December 31st), so there's still about a week left to sell.
[–]rydan 0 points  
No, please sell immediately to realize your tax benefit now. If you don't sell now someone else will and you'll receive an even bigger loss.
[–]winstrol 2 points  
I have a bitcoin wallet that has over 700 bitcoins i had from pre 2012. Ive never really thought that i need to report these coins to the IRS since i havent really touched that wallet nor the computer since(in storage). I also don't really have plans to use nor touch these coins until the future. Is what am doing illegal? Am guessing am hiding an asset that was worth nearly a million dollars just a year ago so just wondering.
[–]drcode 2 points  
I am not a tax expert, but my understanding is that untouched coins of any amount can be kept for any amount of time, no reporting needed.[1] Only when you sell them do you have an obligation to report them to the IRS.
[1] The cynic in me says this will change in the near future- I'm sure some bureaucrats will want to know more about everyone's cryptocurrency holdings soon...
[–]danielravennest[🍰] 1 point  
You are not doing anything wrong. The Income Tax taxes income, and your coins are not net income until you sell them. At that point, the difference between what you sell them for and what they cost you originally is your "capital gain". If you live in the US, it gets reported on Schedule D of form 1040 for the tax year in which you sell them.
In the mean time, they are a capital asset, like a house, or collectibles. Their value can go up and down in the mean time, but you don't owe taxes until they are sold at a gain. I recommend reading up on the capital gains tax and how it works, so you will be prepared for when you decide to use your coins. If it's a really large amount, get professional help. There are ways to use your coins without selling them and triggering the capital gains tax, but I'm not qualified to give that kind of advice. Suffice to say if you can borrow against a house or car, you can borrow against other assets.
[–]bobabouey 2 points  
This is generally correct, assuming he bought them.
If he earned them, as a miner or by selling stuff (including services), then taxes were due at the time mined / earned.
[–]danielravennest[🍰] 1 point  
Agreed. The value of the coins mined/earned at the time are business income, from which you can subtract costs to determine net income. For mining you can depreciate your own hardware, and a portion of your internet costs if you were in a pool. If you sold goods and services, their cost is applied like for any other business. The only difference is you were paid in bitcoin instead of local fiat.
I think in the US, your cost basis for the coins becomes their value you figured in the above examples. If you then later sell them for more, capital gains is due only on the increase since then.
[–]zombiecoiner 1 point  
Just a recommendation. I hope you have multiple secure backups on different media and at different geographic locations.
[–]alphamystic007 1 point  
Dont say how many bitcons you have, it makes you a target, and there are some excellent hackers reading.
[–]winstrol 3 points  
Like i said the wallet is on another computer which i don't use at all. Thanks for tip anyways.
[–]fourtrickpony 2 points  
Careful man, these hackers are that good
[–]mjh808 2 points  
CGT is designed to screw you, gains hit you straight away but losses just have to carry over year after year until you can offset with a capital gain or lose the paperwork. I lost around 3k in the stock market like 20 years ago and haven't made a CG since - I don't even recall what company it was.
[–]dblcross121[S] 1 point  
Yep, the loss limitation is very harsh.
[–]drcode 1 point  
Nothing makes my blood boil more than "wash sale" rules... what a stupid, stupid, stupid way to run an economy.
(And please don't say "but then everyone will just sell their stocks at the end of the year and buy them again next year" as if that's some sort of coherent argument... I need some of my remaining blood that has not yet boiled.)
[–]rezzme 2 points  
If I made a large purchase with Bitcoin but the purchase was at a loss, how might I record that? Is it worth the time?
For example: If I have some portion of coins that I purchased at 400, another portion at 360, but I spent 1000 total (70% from the 400 and 30% from the 360) on an item when px hit 330, how do I even begin to figure this out?
All of my purchases would be like this, gain or loss, I just don't feel it's worth the time, but I lack expert accountant goggles on this stuff.
[–]usrn 2 points  
500 bits /u/changetip
[–]changetip 2 points  
The Bitcoin tip for 500 bits ($0.16) has been collected by dblcross121.
[–]mjh808 2 points  
taxes are so last century
[–]rende 0 points  
Agreed. I'd rather pay for individual services from companies than a bulk amount to some group that tries to optimally spend it.
[–]rydan 1 point  
You want every road to become a toll road?
[–]rende 0 points  
In effect it already is, sure. Use a service, pay for it.
[–]GrapeNehiSoda 2 points  
when i did my taxes last year my accountant wanted me to come in to meet to explain the trades to them. They didn't know what Bitcoin was. I basically had to give an overview during the meeting. And of course, they charged me for the pleasure in what was the largest accounting bill I've ever received. Good times.
[–]dblcross121[S] 1 point  
You're not alone in this experience. Fortunately more and more tax professionals are handling Bitcoin related tax returns so hopefully you won't have this problem again.
[–]rydan 0 points  
Well, if someone came to me showing how they just spent $1200 on a Bitcoin I'd be inclined to up my fees as well.
[–]whitslack 1 point  
/u/changetip 1 gold star
[–]changetip 0 points  
The Bitcoin tip for 1 gold star (1,543 bits/$0.50) has been collected by dblcross121.
[–]rdbell 1 point  
Can lost/stolen coins be considered a capital loss of the full amount?
(Goxxed, computer hacked, lost private keys, etc.)
[–]PotatoBadger 1 point  
Yeah. What happens if coins are lost in an... "unfortunate boating accident"?
[–]rydan 1 point  
Guys with guns come to your home, demand all your money, and arrest you for not paying your taxes.
[–]DatBuridansAss 1 point  
Don't be such an extremist. They'll send a strongly worded letter first. It's only later that they dispatch the armed men.
[–]dblcross121[S] 2 points  
No, the type of loss you're referring to is called a "casualty loss" and the rules are much more restrictive, unfortunately.
[–]bubbasparse 1 point  
If one trades on margin and loses some principal, would they have to convert the principal to dollars to realize the loss? For example, transfer 10 bitcoin from coinbase to bitfinex. trade on bitfinex and lose 5 btc. transfer remaining 5 btc back to coinbase.
[–]dblcross121[S] 1 point  
No not necessarily. If your losses are denominated in bitcoins, they are still deductible -- you'd just have to calculate the dollar value of the loss using the applicable exchange rate.
[–]garylachance 1 point  
Anyone know what the rules are for Canada?
[–]midas_sf 1 point  
Could one avoid the economic substance doctrine (and the very unlikely event that wash sale rules might apply in the future) by selling BTC and immediately investing in something like the Bitcoin Investment Trust?
I'm not a huge fan of their 2% fee, I'm more curious about this as a theoretical tax hack.
[–]dblcross121[S] 1 point  
Thats a good question. The was sale rules apply to "substantially similar" assets, so the trust shares might fall within that definition (if the was sale rules apply at all). I'd have to look more closely at the trust shares to tell for sure.
[–]allgoodthings1 1 point  
The "economic substance doctrine" is a doctrine in US tax law that says a transaction must have economic significance aside from it's tax effects.
It occurs to me that this principle also works in the favor of spending or donating bitcoin (for goods or services) and immediately buying back the spend amount. Clearly, that gives "economic significance" to the disposition. This is especially good to know for customers of a service like Coinbase, which allows one to immediately repurchase the bitcoin amount of a payment made.
Of course, there is "economic significance" is every spending or donating of bitcoin -- almost anything except outright selling. So anyone who USES their bitcoin and then replenish their stock on any schedule or time frame is clear of this convoluted "economic substance doctrine" issue.
[–]sandball 1 point  
That's interesting. I wonder what dblcross will say about it. Donating appreciated assets has a nice tax benefit that you can write off the appreciated amount and declare no gain. Donating a depreciated capital asset to a charity is weird to me--you may be better off selling it to declare the loss, so you can use it as already mentioned above to offset other gain, then donate the proceeds to charity.
[–]allgoodthings1 1 point  
Oh, you don't have to sell the depreciated property to write it off. Just donate it to your 501(c)(3), just like you would appreciated bitcoin. You still take a Sch A deduction for the current market value, and you write off the bitcoin loss, just like you do any other loss.
Giving bitcoin directly to a qualified charity.. in all cases you take the tax deduction for the gift on Schedule A. Short-term gain or loss, and long-term loss, you list those transactions just like you would for any other bitcoin disposition - on Schedule D. Long-term gain, you don't report at all on Sch D.
[–]pprimase 2 points  
how about unrealized loss?
[–]dblcross121[S] 2 points  
The losses have to be realized, unless you're a day trader who has made the "mark to market" election. Unrealized losses are ignored.
[–]ichabodsc 1 point  
Great post, thanks for giving a background on the btc tax issues.
A bit tangential, but does the IRS use substantially the same definition of "security" as the SEC, or is it based on an entirely independent line of cases?
[–]targetpro 1 point  
Great write-up. Thank you!
[–]yesboobsofficial 1 point  
Russian hackers stole all my Bitcoin profits and I lost all my e-mails on a harddrive.
[–]Lite_Coin_Guy 1 point  
Thx for that and Merry Christmas! Here are some free Christmas Bitcoin :-) dblcross121 700 bits /u/changetip

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