Nov 4 / Phil Gaudiano, CPA

Two new crypto tax provisions to know

There are a number of tax policy provisions in various stages of discussion in Congress. Relevant to crypto investors are the Infrastructure Bill which is currently sitting in the House of Representatives, and two bills aimed at retirement: the Securing a Strong Retirement Act in the House and the Retirement Security and Savings Act in the Senate.

1099-B Reporting
Most of the hubbub has been about enhanced reporting requirements for crypto brokers in the Infrastructure Bill; drawing them into the Form 1099-B reporting scheme that is used in the traditional finance industry. Forms 1099-B are used to report sales of stocks, bonds, and other securities with information provided by brokers that includes dates of purchase and sale, cost basis, and gross proceeds from sales, among other things.

By mandating 1099-B reporting, Congress is attempting to close the perceived tax gap that occurs from crypto investors not reporting their trading activity properly. However, there appears to be a lack of understanding among those in Congress of how the crypto industry as a whole conducts itself.

One of the main tenets of crypto is self-sovereignty; the right for individuals to own assets directly without the need for a middleman or custodian. With this ability to own assets directly comes the ability to move them freely across wallets and platforms, be it on an exchange, in a third-party custodied platform, or on a hardware wallet. It’s this free movement that presents an issue for the traditional 1099-B reporting scheme.

For example, say an investor has BTC for which she paid $10,000 stored on a hardware wallet which she transfers to an exchange account and sells for $15,000. This sale results in a $5,000 capital gain that must be reported on her tax return.

Under the proposed legislation, after year-end the exchange will produce a 1099-B for her showing the $15,000 sale of BTC, but there will be no basis or holding period information provided because it is impossible for the exchange to know these things. This is because she purchased the BTC outside of the exchange.

For crypto investors who have been meticulous in tracking basis and reporting gains and losses properly on their tax returns, the 1099-B reporting scheme won’t change much in how they prepare their tax returns. Trades reported on Forms 1099-B will need to be moved to another line on Schedule D and on a separate Form 8949, but the end result will be that the same net gain or loss will be reported.

Wash Sale Rules
The next provision in play for crypto investors is the disallowance of wash sales proposed in the new retirement bills. Wash sales occur when an investor sells an asset and then buys that same asset back in short succession for purposes of recognizing a tax loss on the original sale. Under current regulations, these sales are generally not recognizable if the investor purchases the same or substantially similar asset within 30 days before or after the sale date.

Currently, wash sale rules do not apply to crypto trades; investors are free to sell crypto assets at a loss and buy them back immediately with a new, lower basis. Frequent traders have been able to take advantage of short-term market swings to recognize losses in order to bring down their net gains. But that may no longer be the case starting in 2022.

It is important to note here that wash sale rules apply to the same or substantially similar assets, so there is no change to the taxation of trades from one coin to another — the wash sale rules would only apply to selling and then buying back the same coin, and vice versa.

Taken as a whole, these proposals — and other bills introduced in the House and Senate aimed at government oversight of the crypto space — suggest that Congress is eyeing the need for increased regulation around cryptocurrency-related transactions. For those taxpayers who disclose their crypto transactions as required by law, this is a positive step in the evolution of crypto which may perhaps encourage increased adoption across the broader spectrum of US investors.