“Specifically Identifying Exchange-Based Crypto: An Old Solution to a New Problem,” Bloomberg’s Tax Management Memorandum and Daily Tax Report
In an article distributed with Bloomberg’s Tax Management Memorandum (TM Memo) April 8, 2019, Chamberlain Hrdlicka attorneys Philip Karter and Kevin Sweeney discuss means of identifying and computing the cost of cryptocurrency. The article was also shared in Bloomberg’s Daily Tax Report on April 16, 2019.
In order for legitimate crypto transactions to take place, the attorneys explain that a “cost basis must be computed by specifically identifying the purchase price of particular coins sold by the taxpayer.” Though, due to the limited knowledge and legislation surrounding the classification of cryptocurrency, this method is difficult to apply to exchange-based crypto sold by the clients of tax practitioners. As a “technically unauthorized” method, practitioners are using the generally-accepted first-in, first-out methods (FIFO) or finding average cost, which greatly limits flexibility in computing cost basis and can result in “higher capital gains in early years,” the attorneys caution.
The attorneys offer background on the Internal Revenue Services (IRS) Notice 2014-21, which states that “crypto should be treated as property for federal tax purposes,” though it gave no indication of any new crypto-specific rules and regulations and states that any general tax principles that would apply to property transactions shall also apply to crypto transactions.
“While the issue of how to specifically identify fungible property is new to crypto, there is over a century’s worth of case law and regulatory responses for dealing with cost basis computation issues for another type of fungible property—stock in corporations,” they share. “With no virtual currency-specific statutory or regulatory guidance, courts are likely to look to this analogous body of law to determine how taxpayers can calculate crypto basis.” Specifically, they point to Reg. §1.1012-1(c), which contains specific rules stating that if a taxpayer cannot adequately identify the cost basis, it should be computed on a FIFO basis.
The attorneys note that case law concerning corporate stock provides persuasive authority for the position that taxpayers can specifically identify an analogous fungible asset, exchange-based crypto, in a manner courts will deem adequate. “By specifically identifying the highest-cost crypto first, he or she may be able to greatly reduce capital gains in early years,” they share. “To support such a position, it is imperative that taxpayers maintain a record of the types and amounts of crypto bought on custodial exchanges as well as the particular dates of transactions and prices. Moreover, taxpayers must contemporaneously document their intent to sell particular crypto.”
“Although the aforementioned approach appears legally supportable, the law in this developing area is far from settled,” the attorneys explain. “Consequently, taxpayers must be cognizant that the IRS and/or the courts may ultimately disagree with this approach. To avoid penalties in this event, taxpayers should consider having their tax preparer include a Form 8275 Disclosure Statement along with their tax return disclosing this position.”
You may view the full article in the Daily Tax Report here.