4 common challenges tax pros face with cryptocurrencies

Cryptocurrency is most commonly bought, sold, and traded on cryptocurrency exchanges like Coinbase, Gemini, Bittrex and others. In a sense, these exchanges look similar to stock broker sites like Etrade or Charles Schwab that allow users to buy and invest in stocks. Instead of stocks, cryptocurrency exchanges allow users to buy and invest in digital currencies. The difference from a tax reporting perspective is the limitations that exchanges face. Because cryptocurrency is a transferable asset, and users can send and receive it fluidly from their exchange wallets, the cryptocurrency exchanges are generally unable to give users an accurate 1099-B form at year end. This form traditionally breaks down each taxable event, cost basis, and gain/loss necessary for creating Form 8949.

Because of this reporting inability, tracking cost basis across multiple different cryptocurrency platforms becomes extremely difficult for tax professionals. If your client has not been keeping detailed records, it can be helpful to use crypto tax software to automatically pull historical cost basis and fair market value for all trades and transactions.

It is not uncommon for users to have completely lost their transaction data needed for tax purposes. In the past, exchanges like Mt. Gox and Cryptopia have shut down due to liquidity issues and left users without historical transaction data. Other times users simply lose access to accounts.

There is very little that the tax professional can do if a client has lost access to their exchange or wallet account(s) and does not have a record of the historical transactions. The best approach is to work with the client to attempt to put all the pieces together as accurately as possible, then at the end, post a manual adjusting entry to zero out the ending balances for each “lost” account. In order to do this, all the ending balances for each existing account that the client still has access to must be reconciled first.

The cryptocurrency industry is still in its infancy, and regulators still have yet to address how some of the core scenarios seen with cryptocurrencies like forks, air drops, and splits should be treated from a tax perspective. The only official guidance came from the IRS with Notice 2014-21.

Because of the lack of clarity, it is up to tax professionals to interpret the law and draw parallels when able. In terms of events like air drops, many professionals who are well versed in cryptocurrency side on classifying the received cryptocurrency as income using the fair market value in U.S. dollars at the time the crypto is received.

According to IRS Commissioner Charles Rettig (pictured), further cryptocurrency tax guidelines will be released in the near future. The guidelines will focus on providing clarity for “acceptable methods for calculating cost basis, acceptable methods of cost basis assignment, and the tax treatment of forks.”