For some, cryptocurrency and NFTs are a headache. For others, taxes are a headache. But when you combine them all, you’ll find widespread confusion, even among experienced investors. In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Micah Fraim, CPA, Partner at Fraim, Cawley & Company, CPAs and the bestselling author of Decrypting Crypto Taxes and The Little Big Small Business Book. Fraim is a self-proclaimed crypto- and NFT-obsessed CPA with a slew of knowledge to back it up!
In this episode, you will learn:
- How cryptocurrency trades and NFTs are taxed.
- Tax-efficient strategies for crypto and NFTs.
- How to track your cryptocurrency activity in preparation for tax season.
- IRS laws and legislation on cryptocurrency and digital assets.
- Future forecasts for cryptocurrency/digital asset tax.
- And more!
cryptotaxcpa.com | fraimcpa.com | Decrypting Crypto Taxes | IRS Resource: Frequently Asked Questions on Virtual Currency Transactions | The Little Big Small Business Book | Schedule an Introductory Call | Bautis Financial: 7 N Mountain Ave Montclair, New Jersey 07042 (862) 205-5000
Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.
Welcome back to The Agent of Wealth Podcast, this is your host Marc Bautis. On today’s show I brought on a special guest, Micah Fraim, to talk about cryptocurrency taxation. Micah is a cryptocurrency and NFT-obsessed CPA and the bestselling author of Decrypting Crypto Taxes and The Little Big Small Business Book. Micah, welcome to the show.
Hey Marc, thanks for having me.
I’m excited to talk to you today about cryptocurrency and taxes because there’s a lot of confusion in this area. But before we get into the details, how’d you get involved in this area?
I got involved initially just because I was invested in cryptocurrency. In 2017, during the ICO craze, I bought a couple grand worth of crypto. And given that I was buying at what was the peak, the $3,000 I put in turned into $1,000 very quickly. I forgot about it for a few years, but come 2020, I checked the balance and it had recovered to be worth somewhere between $6,000-$9,000.
At the same time, I had a client who told me about this crypto project he was involved in. It was the first time that I understood the use case and utility of a specific crypto project, because I’m not a tech guy. I heard people say, “Blockchain technology is a big deal. This is going to be the future.” And, at the time, I’m like, “Okay, blockchain itself is a big deal. But why is Bitcoin or Litecoin or Ethereum?” I didn’t understand why each individual project or token would have any value.
So, after speaking with this client, I gained an understanding of why a specific project would have value.
I started investing in that, and that cascaded into more interest in investing. When it came time to do tax planning for myself, I very quickly realized there was next to no guidance out there. Then, because a lot of our clients are online-based businesses, they are naturally inclined to invest in crypto, and we were getting more and more clients asking about taxation of cryptocurrency.
Makes sense. So, let’s get into it. How are crypto trades taxed?
How Cryptocurrency Trades Are Taxes
So what will foul people up is the big myth in crypto circles that none of the crypto income you have is taxable until you cash out for a fiat currency like US dollars. Some people think that if you’re trading Bitcoin for Ethereum or Solana, or whatever other tokens, that those aren’t taxable events until you actually swap it out for US dollars. Unfortunately, that’s just not the case.
The IRS hasn’t issued much guidance on crypto taxation, but one of the things they’ve very explicitly noted is that these coin for coin or token for token trades are each taxable events.
So, essentially when you sell one and buy another, that’s basically the equivalent of selling Apple stock and buying Google stock, in terms of it being a taxable event?
Exactly. A lot of people don’t realize that, so they don’t report any of their activity.
The other thing that will happen is, given how insanely volatile the crypto market is, you can have it to where people are doing all of these individual transactions and are making a bunch of money. So, they’ve got taxable gains that got built up, but then the next year or later in the year you have it to where it crashes down so they can lose all of that value but still have a huge tax bill.
It’s like the same concept as an unrealized versus realized gain, and the volatility is just on steroids in the crypto world.
Yeah, it’s the exact same thing. To your example of Apple and Google stock, you’re not having one week your Apple stock is down 50%. So, it’s the same as a traditional security would be taxed. It’s just that people are doing it in a much riskier environment. Given that, if you cash out whenever you have gains, you’re good. But most people don’t do that.
We’ve had people come to us for the 2021 tax year with six to seven figure gains in crypto projects, but they didn’t cash out at all. Then, the value of the project or the token they invested in went down, some 50-99%, depending on how risky the asset was. So there are people who had seven figure incomes just from crypto, which generates six figure tax bills, but their portfolio is not even worth that much anymore.
Yeah. Is crypto the same as any other asset, in the sense of a long-term versus short-term capital gain/capital loss?
For regular crypto tokens, that’s absolutely the way that it goes. It’s just holding period cost basis and your sale proceeds. You can get short-term or long-term capital gains treatment on that.
How NFTs Are Taxed
For NFTs, the IRS hasn’t issued any specific guidance yet, but the general consensus is that most NFTs are taxed as collectibles. So, even if you hold it for over a year and you’d normally get long-term capital gains, you’re going to be paying 28% versus the 20% that you would with a regular capital gain.
Okay. We’ll go into some of the NFT specifics in a second, but I had a couple of other questions about crypto.
First, is crypto also impacted by the wash sale rule? If you sell for a loss, can you re-buy immediately? Or do you have to wait a specific amount of time before you’re able to re-buy that specific token?
Crypto and The Wash Sale Rule
Right now, crypto is not subject to the wash sale rules, which is a huge advantage. There have been several proposals over the years trying to close that loophole, but they haven’t gotten a whole lot of traction yet. I think, at some point, it will happen… But at this moment in time you don’t have to deal with the wash sale rules.
With crypto as it exists today, it’s pretty simple. You’ve got something that has a huge unrealized loss on it, you can sell it and immediately buy it back, but at that point you’ve realized the loss and then can use it to offset against other capital gains you have. Or, just carry it forward to future years.
Yeah. And a crypto loss can offset a gain from any other type of asset, correct? Or is it specifically crypto loss against crypto loss?
Everything goes into different buckets. Crypto losses go into the regular, Schedule D capital gains and losses – the same as stocks. So, if you have a huge loss in crypto and a bunch of gains in your trade in the stock market, those two do offset against each other.
Speaking about Schedule D… I know if someone has a regular brokerage account, they get a 1099 from the custodian at the end of the year that shows income, capital gains-
Yeah, it’s beautifully buttoned up with every piece of information an investor could possibly need.
Exactly. Does the same thing happen with crypto wallets? Or is it on the investor, or the crypto holder, to do everything themselves?
How to Track Crypto Activity
It’s largely on the investor right now. The SEC and IRS are trying to wrap their arms around it a bit more, but right now it’s up to the investor to track activity, as none of the crypto exchanges will issue you a formal 1099. Actually, I think Robinhood Crypto and a few like that function differently, since they’re under a traditional securities firm, so they will send out a 1099, but most of them won’t.
But the centralized exchanges like Coinbase do have to keep track of the stuff that’s happening on the exchange. So, at the very least, they’re keeping track of the sales proceeds and the cost basis of the stuff you bought on that platform.
The problem is if you’re on a decentralized exchange, or even if you’re on, let’s say, 10 different centralized exchanges and you’re transferring the money back and forth… Nobody is keeping track of the holding period, cost basis, any of that. So, if you’re just trading on one exchange like Coinbase, they’ll give you a report that will give you the majority of the information you need to file your tax return. But if you’ve got any sort of advanced activity or if you’re in the defi space, you’re not getting any of that. So, it’s on you to keep track of your activity, which is a nightmare regardless of how you cut it.
You can either try to manually do it on a spreadsheet, which is next to impossible, or you use a specialized software like CoinTracker or Koinly. Those kinds of software programs do a pretty good job, but they only get you 90% of the way there – you still have to make manual adjustments yourself, because it inevitably doesn’t properly capture the reality of the transactions.
Makes sense. So, we’ve talked about crypto transactions, capital gains/loss and reporting. What about income? I know there are some platforms out there where you can lend your crypto or even staking crypto and income is generated. How is that treated with respect to taxes?
Right now they’re issuing, it’s not exactly interest or dividend income because it goes on a different portion of the term, but it’s generally just taxed as income upon receipt. So, if you’re getting that on a Coinbase or one of these platforms, those already required to do more reporting for you, they’re either going to issue you a 1099-INT for interest or a 1099-Miscellaneous for whatever deposit rewards or staking income that you received from that. So, that’s pretty straightforward. Where it gets complicated again is if you’re doing it on defi.
Also, if you have a ton of crypto, which will then be generating a ton of staking income or deposit rewards, the volatility can foul you up because it’s taxable upon receipt and at the value the token was as of the date you received it. So, if you’re given a couple thousand dollars of staking rewards, who cares? It’s not going to make a huge difference. But if you’re in one of these protocols that gives ridiculously high interest rates and the market isn’t tanking, that can add up quicker than people realize.
Sure. Does crypto qualify for 1031 exchange, similar to real estate?
Does Crypto Qualify for 1031 Exchanges?
No, and there’s two reasons for that. One is that when they passed the Tax Cuts and Job Act in 2017, after crypto had its first mainstream boom, they anticipated people were going to try to take that route, so they amended the tax code to very specifically say that 1031 exchanges can only be done for tangible assets. So, intangible assets are completely off the table.
A question that typically comes up, which is more of a point of curiosity because it’s 2017 and before, is: “What about before the tax code was amended? Could it have been done prior to 2017?” Several years later, the IRS issued guidance saying no.
It’s similar to the way that they treat gold and precious metals. You can’t swap gold and silver and as a 1031 exchange, because they say the utility is different. The IRS examined Ethereum, Litecoin and Bitcoin, breaking down why people hold them, what their value is and what the use proposition is, and said, “Even prior to 2017, we’re not going to allow you to do this just because we think that they’re different enough that they’re not like-kind.” So, on both counts you get hosed on that.
Is Paying With Crypto Taxable?
Okay. One thing that we always hear about crypto is it’s going to evolve into a real currency. Some time in the future, you’ll be able to walk into Starbucks and buy a coffee with crypto. Would that actually be a taxable transaction, since technically you’re selling crypto to buy a good or service?
Right now, unfortunately, yes. That’s the way it is. But so far, crypto has failed pretty badly at being an actual currency, because the processing times are largely too long.
There’s a lot more traction around crypto debit or credit cards. The debit cards are basically a prepaid card loaded with your crypto and every time you swipe, you’re spending it. Right now, it doesn’t matter if a $1 transaction, it’s a taxable event that you have to report.
There’s a couple of people in Congress who proposed legislation for transactions under $200 to be exempt from the IRS reporting requirements and it being a taxable gain or loss. If that gets enacted, it would be a huge advantage, saving people a lot of hassle. But I think they’re going to have to tweak it a little bit, because they will have to look at the aggregate number of sales in a certain period. Otherwise, people could sell $2 million in Bitcoin and use that total amount in multiple transactions of $199 or less.
We’ll advise people to do one of two things. One, they can get a crypto credit card. Credit cards are a little bit different because you’re not actually spending crypto, you’re just accruing a liability and then they’re paying you in crypto rewards instead of giving you cash back or points. So, a crypto credit card avoids the tax consequences. The second option is to load your debit card with a stablecoin, which at least stays at a dollar. So, even though you’ve got to report the proceeds, you’re not going to have a taxable gain.
Got it, that’s good advice. So, I know that the world of crypto is evolving very rapidly, and I’m sure regulatory changes are constantly coming about. What do you see coming down the pipeline on the tax side of crypto?
Future Forecasts for Crypto and Taxes
I think there will be a tremendous amount of lawsuits. Because so far, the IRS has issued guidance on a very scant number of things. In summary:
- Cryptocurrency is not subject to 1031 exchanges.
- Coin for coin trades are taxable.
- Crypto wallets are not considered foreign bank accounts for FBAR filing.
- Hard forks and airdrops are taxable income.
- Mining income is taxed as business income.
But that’s about it. They still haven’t issued explicit guidance when it comes to staking rewards, NFTs, nodes… In a space that’s rapidly evolving, the IRS hasn’t issued any guidance on the majority of it, and there’s not much legislation coming out of Congress at this point.
So given the lack of guidance and legislation, we expect there to be a lot of litigation. People are either going to challenge the established IRS position or try to force the IRS to give a stated position through litigation.
Yeah, it’s definitely going to be interesting to see what comes in the future.
Tax on Stolen, Hacked or Lost Cryptocurrency
What happens in the event that an NFT or a token becomes worthless? Is it just a straight capital loss? Can you deduct it?
You can deduct it, but there are some steps you have to take, similar to traditional securities. If you own something that becomes worthless, you have to permanently dispose of the asset. Because even if it is worthless, until you have relinquished all ownership and potential benefits from it, they don’t let you write it off. We’ll typically do this by sending it to a different wallet with its own wallet address – a dead wallet that you don’t have any access to. That way, it’s out of your possession with no way for you to retrieve it. You’ve permanently disposed of it.
What about in the event of fraud? I’ve heard so many stories about wallets getting hacked. Is that similar to worthless crypto, or is that treated any differently?
You can write it off as worthless crypto, or you can report it as a casualty or theft loss. Sometimes the latter provides a significant advantage, because it ends up being the same as if you took the capital loss. So you’ve got a couple of different options depending on how much you lost and your particular situation.
And, let’s say I bought the crypto for $10,000 and at the time of the hack or fraud, it was worth $20,000… is that any different than if it was worth $5,000?
Unfortunately, you’re stuck with whatever your cost basis was. That’s frustrating because you had all of this income that then got stolen from you.
We’re seeing these issues with some of the centralized exchanges. For example, Celsius and Voyager both went bankrupt. First withdrawals got suspended, then they went bankrupt. In some cases, people deposited all of their crypto tokens onto those exchanges. For example, a person could have bought Bitcoin at $2,000 and then got locked out of their account when that Bitcoin was worth $50,000. In that case, they’re only able to write off the cost basis, even though the exchange went insolvent and froze them out. There’s some significant opportunity costs there, but unfortunately there’s no mechanism to account for that on the tax return.
Yeah, that’s terrible. Are there any strategies that someone can implement, whether they have inherent gains or inherent losses, in crypto or NFTs to set themselves up going forward?
Tax-Efficient Strategies for Crypto and NFTs
It really depends on how you’re investing, the scope of your investing and the particulars of your situation, but there’s a few things that we’ll recommend for almost anybody.
Since crypto is not subject to the wash sale rule and the fact that crypto is in a bear market, it makes sense to realize losses of consequence. Now, not if you’ve got a hundred dollars of unrealized loss, but if you’ve got anything significant, it makes sense. Either it offsets against the gains you have this year, or it carries forward. The only downside is going to be the fees of processing those transactions. But again, if it’s a big loss, that absolutely makes sense.
The other thing is, in certain types of crypto income, you might have some level of control as to when the taxable events are generated. In a bull market, we usually try to push that off as much as we possibly can. When you’re already in a higher income tax bracket, we don’t want to generate more income than necessary. But if you’re in a low income year, it might make sense to actually take the hit now, accelerate your income, and then you’ll experience significant tax savings down the road.
The other thing that we’ll talk about is really basic, but I can’t tell you how many people don’t do it. As you have realized income – staking rewards, trading income, mining income, etc. – make sure you’re cashing out a portion of that into a fiat currency and setting it aside for taxes. I’ve worked with people who made a million dollars the previous year in crypto projects, but just kept reinvesting into the projects. Then, the project dropped, say, 90%. In those instances, you could have a $500,000 tax bill, but your portfolio is only worth $100,000-$200,000 now. In those cases, we usually have to liquidate their portfolio at a really low price just to try to pay the tax bill.
Instead, whenever you make transactions, cash out 40% and put it into a savings account for tax season.
Yeah, great advice. One last question for you, can crypto be purchased inside an IRA or a Roth IRA?
Yes, there’s a handful of companies that will do it within an IRA or a Roth IRA. I think there have been whispers about some solo 401(k)s maybe instituting it, and likely some of the self-employed plans will allow it down the road. But right now, it has to be done through a special custodian and company.
Okay, got it. Well, that just about wraps up today’s episode. Micah, I’d like to thank you for being on The Agent of Wealth Podcast today. You provided some great insight into the world of cryptocurrency and taxes. How can someone reach out to you to find out more about what you do?
If you’re a crypto investor, the best place to go is cryptotaxcpa.com. If you’re a regular business or have a more traditional setup, you can go to fraimcpa.com. And if you have questions about crypto tax but aren’t at the point where you need to hire us yet, we do have a book you mentioned at the outset, Decrypting Crypto Taxes, which is free on Amazon right now – it’s a no-cost digital download. Every chapter of the book is basically a frequently asked question. So, if you go to the table of contents, hopefully the issue is addressed and easy to find.
Awesome, we’ll link to all that in the show notes. Thanks again for joining me, Micah. And thank you to everyone who tuned into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.