In this episode, we talk about why crypto taxes are so difficult. We cover some of the biggest misconceptions or mistakes people make when doing their crypto taxes, how to get smarter about taxes this year and in the future (e.g. tax loss harvesting) - then really enjoyed going into more detail around some of the specifics on things like: wash sale rules, NFTs taxed as collectibles, FBAR, Airdrops, Staking Income, etc.
Enjoy the episode with Micah on Crypto Taxes.
0:00:00 Welcome and context
0:03:35 What is your background?
0:05:05 How is crypto treated in tax terms?
0:10:41 What needs to change so crypto can be treated as currency in tax purposes?
0:11:31 What are the biggest misconceptions when it comes to crypto taxes?
0:14:59 How to take advantage and limit tax liability in volatile markets?
0:20:00 Using capital gains to offset crypto valuations
0:23:31 What are some of the best practices for keeping track of taxable events?
0:27:08 What can people do throughout the year to track their crypto taxes?
0:30:07 Where is the IRS right now?
0:32:52 How are NFTs taxed?
0:39:40 How to recognize NFT value loss without selling it?
0:42:15 Techniques for off-writing losses
0:47:00 Taxable gains from airdrops
0:51:01 Should you report crypto that's held in an overseas exchange?
0:52:51 Where can people find out more about you?
[00:00:00] Ben: in this episode. Some of the biggest misconceptions or mistakes that people make when doing their crypto taxes, how to get smarter
about taxes this year. So this is timely before the end of the year. There's some things you can do tax loss harvesting,
but we also, I, I really enjoyed this conversation going into more detail on some of the specifics, like wash sale rules, NFTs, taxed as collectables, f bar airdrops, staking income, et cetera.
There's a lot here. Six episodes, including this one were recorded in early November. And honestly, with the FTX SBF fiasco, I haven't been able to publish any of these in a timely manner. So I have a few episodes queued up and I'll link a great overview to what happened with FTX in this show notes. But, It's been discussed as ad nauseum at this point.
So the key points here to remember are cryptos not broken. FTX was a centralized exchange that blew itself up. People trusted spf, but sexes, centralized exchanges are run by humans, and ego, greed, nefarious intentions come into play. Yes, there's probably some more collateral damage to the industry but it will survive.
And Web three really isn't going anywhere. It's a bear market, yes, but it's not a crypto winter. With smart entrepreneurs entering every day, tools in infrastructure being built, all time hel high developer activity and tons of VC money waiting to deploy, it's not going. Check out the link in the show notes on the summary.
It's from punk 65 29. I think he does a great job. Okay, crypto taxes, this episode, I'll get off my soapbox at this point. In this episode, we talk about why crypto taxes are so difficult. That's it. That's the point. They're not easy. It's early. For example, centralized exchanges, people using names, they're blowing up whatever, but also the tools that you have to do your crypto taxes we're covering.
in this episode. Some of the biggest misconceptions or mistakes that people make when doing their crypto taxes, how to get smarter about taxes this year. So this is timely before the end of the year. There's some things you can do tax loss harvesting, but we also, I, I really enjoyed this conversation going into more detail on some of the specifics, like wash sale rules, NFTs, taxed as collectables, f bar airdrops, staking income, et cetera.
There's a lot here. Before we jump into the episode, I wanted to take a second to thank you for being a listener. I know I'm horribly inconsistent at times in producing these. Come on. It's, it's a side thing and I do enjoy it, but I really appreciate your listenership and appreciate all the messages, comments, like subscribes, all of them.
So thank you. Okay. Enjoy the episode with Micah on crypto taxes. Micah, welcome to the Alta Asset Allocation Podcast. Excited to have you on today, sir.
[00:02:58] Micah: Yeah, thanks for having me, man. I appreci.
[00:03:00] Ben: Yeah. And you know, the, the standard disclaimer, none of this is legal tax accounting advice, consult with your own accountant.
You are an accountant as cpa, but you know, you're not the individual listeners, accountant. Yeah. And I'm sure they're, they're individual tax considerations very widely. Mm-hmm. We're gonna talk about crypto and taxes today but definitely wanna float that one out there before we get going. Let's start off.
You're crypto obsessed, so let's start off with your background, how you got interested in crypto and keep it, you know, somewhat short and then we'll dive right into it. Sure.
[00:03:36] Micah: Yeah. So I first got involved in crypto with the ICO craze in 2017, threw in three grand, quickly turned into one grand, and then I forgot about for a few years.
And then when the market started to turn around in 2020, That one grand had turned into six or nine grand, somewhere around there. And right at that time, a client of mines was involved in a node project. And I always say in the years preceding that I always understood that blockchain technology was big, smart people.
So was the future. But I had a really hard time understanding why the individual tokens had value because, yeah, blockchain itself. But why does fill in the blank token, why does that have value? Especially when people can just for fork, the te. This and that was the first project where it just, it clicked and I really understood.
So then I started diving into, you know, that was sort of the red pill and I started diving more and more into it and very quickly realized there's no tax advice out there cuz I'm, I'm wondering for myself, and I'm having more and more clients who are getting involved in crypto. Very, very quickly realized the guidance is scanned.
And even like, I love being a crypto investor. I love just the space in general, but quickly realized that the tax side is more of an opportunity than even the investment side. Yeah, and
[00:05:00] Ben: I mean a lot of that Like the fish rots from the head. Right? That feels like there's unclear guidance from the very, very top, which like trickles all the way down into this somewhat opaque, difficult concept for most people anyways.
It just makes it, and some of the tools, the infrastructure required to like actually. Do your taxes across multiple exchanges and blockchains and layers and all of this stuff, like, gets very, very confusing very quickly. So I think yeah. Yeah, it's a, it's a, it's an area where we need a lot of help as crypto people.
Mm-hmm. . And so let's start off just by setting the stage with. Perhaps like definitions within the crypto world or like principles that we should keep in mind before we like journey into this world of crypto taxation. Like is it treated as property or currency? Like those sorts of things. Well, well,
[00:05:53] Micah: that, that's the difficulty, right?
That's even like the first question. It is. So, oh, why are people confused? . Even that, which is like a very fundamental question we don't have great clarity on, because not even getting into the s e c complaint right now, where they're claiming Ripple and these other things are, are unregistered securities.
Even on the tax side there, there was a case that unfortunately recently got dismissed by the US District Court, where it was the Jarret versus USA case, the couple who had Tezos tokens. We were really all hoping that would give us a lot, a lot of clarity on what, how staking income should be taxed.
And unfortunately, the IRS issued them a refund. The couple tried to just deny the, the, the couple tried not to accept the refund and keep the case going. And the court said, we're not here to offer an advisory opinion. We're here you sued for a refund of your tax. The iris gave it to you. The, the, the cases moved, so that was a real kind of blow to all of us hoping for some more clarity.
The reason I bring that up is, When the IRS and the little bit of guidance they've given, and in that case, when the couple was filing their complaint, they almost quoted the IRS verbatim saying Cryptocurrency is for federal tax purposes, considered property. Cuz that's what the IRS says on their, on their faq.
And the IRS in their response. Most people didn't catch this or cover it. The IRS denied that cryptocurrency in all cases is considered property. So even just to the most baseline thing of is this property is a security that's being debated right now. So right now, the way we have to treat it is as property.
That's the Iris guidance that Iris has issued, and there's nothing. Authoritative that is contradicting that, but it's also something that's likely to change as regulation becomes clearer and more comes out. But for now, really long winded answer. For now, it's considered
[00:07:58] Ben: property. No, but I think this long winded answer kind of sets the phase, the stage for why this is so confusing, right?
Yeah. And then for me, when thinking crypto is property, you know, I, it starts making me think of like 10 31 exchanges and all of these like specific tax code that is specific for. Real estate property, but mm-hmm. , perhaps let's go down that rabbit hole a bit because that's not the case. Yeah. Or, or maybe it is and I've been doing
[00:08:28] Micah: things wrong.
No, unfortunately it, it's not, and there, there. There's two reasons for that. One is that when they did the Tax Cuts and Jobs Act in 2018, that was right after the ICO craze. So, and, and the crash that came after the ICO craze. So when they were doing the re revising the tax code, they very specifically said that you can only do 10 31 exchanges for tangible property.
So intangible assets like crypto don't qualify. But interestingly, some people asked, okay, that's 2018 forward. What about, what about before that? Could you have done a 10 31 exchange? If they get audited or whatever for prior years, could they have done it? And the IRS a couple years ago said, no. And they compared Bitcoin, light Coin and Ethereum, cuz you know the iris is five years behind.
So light coin was. Was one of the big boys.
[00:09:20] Ben: It's not just the IRS man. You see these like new, like Fidelity is able to include crypto currencies like, like coin, and you're like, what the hell is going on? But
[00:09:30] Micah: yeah. Yeah. Right. So, so anyway, they, they compared the utility between those three tokens and they said even though they're all cryptocurrencies, the use case and utility for all these is different enough that we don't consider them like kind and the i, that that's in line with the way the iris is typically treated like kind exchanges, because they won't, even if you're doing precious metals, gold and silver, they won't let you do 10 31 exchanges because the use case for the two is different.
So unfortunately, Especially since coin for Coin Trades are taxable events, unfortunately, you can't just claim these are 10 31 exchanges that you're, you're swap.
[00:10:07] Ben: Yeah. And I think that is probably one of the biggest misconceptions I see when talking to people is mm-hmm. , you know, they say, oh, I thought it was only taxable when you go back to dollars or, or fee it or stable coins.
And you're like, no, no. Literally every transaction coin for coin is also a taxable event. And then, Yeah, and we'll get into that because I think that's these like misconceptions are super, super important to kind of double click on. But I'd be curious, like staying on the crypto as property and, and you know, not in an intangible property, what would be the implications if crypto was changed to being considered a currency from like a tax perspective?
I don't know. No worries. Well, I mean, that's pretty far out and right now it is property and we'll
[00:11:00] Micah: treat it like property, I guess. We'll right. I
[00:11:01] Ben: we'll see what the repercu repercussions of it is, in fact changed.
[00:11:05] Micah: Yeah. That's not something we thought about as much, just because it doesn't seem like that's the, the way it's going to go.
And that's something I do need to look, I, I wanna look at it. That's that. You raise a very good question. Well, tight, hot by hyper. Where the, where the legislators are moving, it seems like there's gonna be a division between some crypto be continuing to be property and some of them falling in line to be securities or them trying to get all of them to be securities.
Being considered a currency doesn't, especially cuz it just crypto fails as a currency, at least as it stands right now. So that's not where the, the whispers that we're hearing aren't about that being the route they'll take.
[00:11:45] Ben: Makes sense. All right, let's just dive right into it. The big misconceptions that you see or hear with crypto and taxes, and even like the number one mistake made by most people when thinking about their crypto taxes.
[00:12:01] Micah: Well, I mean, you, you, you hit the, the main one where people will think it's not taxable until they convert it back to a fiat currency. And that's, that's one thing if you're just a hurdler and you're just buying it, just leaving it alone because you're not having a. Taxable events, but if you are actively trading, if you're mining, if you're getting staking rewards or depo deposit rewards on a centralized exchange, all of those are taxable in real time.
And the issue becomes when we've got as much volatility in the space as we do, you can have people who are having a bunch of realized taxable events and taxable income at, at whatever the price point was when they. You know when things are hot and then they don't cash out cause they don't think they'll have a tax bill.
And then the market plummets and you'll have cases where people have, I've seen someone who had a million dollars of realized gains and no income and other staking rewards, all, all the stuff. But they did not ca, they kept reinvesting it back into the projects that we're making them that money. And then the projects go down 90% so they've.
A tax bill based on the income they were earning on a hot market. But their reserves in their portfolio are 10% of what they were before and they don't have money to pay the tax bill. So one, being aware that of when these taxable events are is the main thing. And the second thing is, And this is crypto zealots.
Don't like this cuz you always want to have the upside. But when you're having those realized taxable events, make sure you're cashing those out, a portion of it out to set aside for your tax bill. And we also tell people, please don't put it in stable coins because. This is something you need to be able to access.
And if you put it in u t or deposited U S D C, even on Voyager or Celsius, then you're gonna have a really bad time. So know, know that they're taxable events and cash out as earning and put it into an actual Ft I insured bank account so that you can pay when tax time comes. So those,
[00:14:12] Ben: those would be the big ones.
And I mean, for I'm a perfect example of this in 2021, right? You buy an NFT for next to nothing, sell it for five E when E is at $4,000. So you have a $20,000 gain, your taxed $10,000 on it. But in the reality, you just have five E in your wallet, which now at current is, is $5,000. So I owe $10,000 on this trade and the value.
All the assets that I brought in are sitting at $5,000, so I'm insolvent just on this one trade. So this multiplied across an entire portfolio for somebody if they're not pulling out a little into stables, into dollars in an F D I C account. They're gonna be totally, totally screwed when it comes to tax time.
I've talked to many people that are in this situation and fortunately, you know, I set aside money, but like, it, it's frustrating for me to see this five E in my wallet that is worth. $5,000 and know that I have a $10,000 taxable event on that. What can people in my asking for a friend, but what can people in this sort of situation do to kind of.
Take advantage. Long term holder. Believe that youth will be higher in the, in, in the long run, but like, want to take advantage of this. Like, Hey man, I've already paid $10,000 in taxes on this. It's worth five. You know, wash trading I think was legal. Yeah. Or, or yeah, wash trading was legal there for a bit.
Like what can somebody in this position do to, to limit their tax liability in future years and take advantage of this unfortunate situation.
[00:15:51] Micah: Right. Well, I mean, you, you hit on the main one as it stands now, and there have been several proposals to close this loophole, but crypto's not subject to wash sale rules right now.
So when you're trying to take advantage of your losses with traditional securities, you've, you've gotta wait the 31 days and you either have to. Sometimes brokers will do stuff with options or some sort of similar asset to try to keep your market exposure, or sometimes you're just out of the market for that month hoping that there's not a bunch of upside that you're missing out on.
With crypto, we don't have that difficulty with crypto. At least for now, you're able to sell all the crypto you're holding at a loss, realize those losses, and then buy it right back. So with the way the market is right now, that's one of the main and pretty easy to execute things that we tell people to do.
The only downside to that really is just whatever the exchange of the gas fees are gonna be. So the losses you have need to be reasonably substantial just to justify the transaction fees. But, There, there's a huge amount of opportunity in that. The other thing that we'll talk about that is a little counterintuitive and it doesn't help you for the 2021 gains, but, and it doesn't even inherently help you for the current year, but it will help you in future years, is since we're.
In such a bear market right now, and most people are making way less than they were in previous years. Well, the US tax system is progressive tax rates, so the more you make the higher rate you're paying and in a decent number of cases, we're actually advising clients to accelerate their income when they actually have the opportunity to do that.
Because there are certain node projects and you, you obviously have control over when you're making your trades. But if you have the ability to have the taxable events hit now, there are certain circumstances where doing that will will save you significantly down the road. I'm being kind of vague here, so I'll give an example, and it's an example that is a little too specific for this project, but it gives kind of a, a, a decent illustration of how it works the way that when you have node income, and this is true, Hard forks, air drops there.
There's a term called when you have dominion in control. So the IRS says that when you have dominion in control over the asset, that's when you have to claim it as taxable income. Well, one of the projects I love is, is gala games nodes. And there's also Connect note they've got sort of related ecosystem, but gala games, notes.
It's right now on Ethereum and they're moving to their own blockchain. But given the gas fees of Ethereum, when they're giving you your node rewards every day, you, you don't want those to actually be on the blockchain because the gas fees are going to be more than what you're receiving. So it goes into the sort of treasure chest, which where you're almost getting a voucher that you can then redeem for the actual token on the blockchain.
Given the, the principles of what the iris has given us, our contention is that it's not a taxable event, and, and you don't have dominion control until you min it to the blockchain. So normally in a bull market, you're trying to defer that as much as possible. You don't wanna min those tokens because then you're going to have a taxable, taxable income.
But, The token is worth 10% of what it was last year. It can make a lot of sense to take the hit now claim that income at 3 cents per coin versus the 50 or 60 cents it got to at its peak. Not only then are you reducing the amount of income and you're also starting your holding period for capital gains purposes, so you can qualify for long term capital gains.
So that's one of the things where sometimes it makes sense to take the hit now, but when you do dispose of the tokens down the road, you'll end up paying significantly less. Gotcha.
[00:19:49] Ben: So, and that also like ties into wash trading. So if I have this, this like five E, you would just to, to, to wash. Sale, wash sale, not trading, sorry to, to trigger a wash sale here, which is allowed in crypto is would sell this E into U S D C or a stablecoin and then rebuy it back.
And so I would lock in that loss that I sold mm-hmm. and then reestablish a new cost basis at that new purchase price. But so how, how do these. How, talk to me about these losses. So speaking to the audience here, presumably in 2021, there were massive gains, big taxable income, 2022. You're doing all of this smart stuff, you're capturing massive taxable losses.
How do these losses, how often do they carry forward? For how long what sort of gains can you use to offset them? Because can you use these to offset earned income or does it have to be a certain class
[00:20:51] Micah: classification? Not much. So the, you're able to use up to, if you don't have any capital gains to offset against them in the current year, you can use up to $3,000 to offset against your, what they call ordinary income, so your business income, W2 wages, stuff like that.
In the current year, it doesn't always give you a huge benefits. It's just $3,000, but those losses don't go away. They just get carried forward indefinitely. So it's some, that's a strategy that. Sometimes doesn't say, especially in a bear market like this, you don't have a lot of capital gains a lot of times.
So in the current year it doesn't do a ton for you. But then if next year the market turns around and you're having a bunch of realized gains, you've just got those losses hanging out there waiting to be used. So then the transactions where you do have profit are effectively tax free.
[00:21:44] Ben: So only $3,000 can be used to offset ordinary income, which is like earned income, W2 or whatever.
But an unlimited amount could be used to offset realized gains, which would be like capital capital gains, but not like interest income. Where would that be considered?
[00:22:05] Micah: That's gonna be in that same sort of ordinary, ordinary income bucket. So the only thing you're gonna be able to use this to offset against is either the $3,000 or other trading income you have.
It's not gonna be able to be used against staking income, liquidity pools, mining nodes, anything like that. Unfortunately, they're just in completely separate buckets. Gotcha.
[00:22:23] Ben: Yeah, cuz that three like, I mean, you know, I. People that lost like seven figures in this whole Luna debacle, and it's like, oh yeah, do you
[00:22:31] Micah: get $3,000
[00:22:32] Ben: every year for the rest of your life?
It's like, I'm not gonna live that long, man, . But the idea of them using that million dollar loss because it went from something to zero to offset any kind of realized gain. So I sell my house, I have a big realized gain. I can use those crypto losses to offset that.
[00:22:51] Micah: Assume, assuming your, your house, there's a, there is a primary residence exclusion if you've lived there two outta the last five years.
But assuming that you have more than that in a gain or that it's a different, you don't qualify for that, for whatever reason. Yeah. Any, any capital gains like that you can use to offset against it. Okay. Okay. That makes
[00:23:09] Ben: sense. No, so that, that, this makes a lot of sense. I'd be curious to go next. I.
Keeping track of this is a bit of a disaster. So there's there's probably best practices checklist of like what to be doing during the year to help. Like I've actually started, like this whole spreadsheet, whenever I do a transaction, I like drop some notes in there so I can a notate what happened, right?
Because it's hard to remember all this stuff. But that's pretty tedious. And there are softwares. Yeah, I've used all the flipping softwares, but like, Some don't support certain blockchains and some don't support other L two s or staking or, or these sort of things. So let's share some like best practices for people so they can get ahead of this, like pending wood chip or disaster that they walk into every, every year.
[00:23:58] Micah: I mean, the main thing is gonna be, I, I always say if you're just trading on. Maybe even two centralized exchanges, you can probably just use the reports that they, they have, because Coinbase and most of the centralized exchanges now are required to keep, keep track of that. But if you're trading on true D five platforms or if you've got 10 different accounts, because you don't want to have all your money on FTX or sales or Voyager, and you wanna have that spread out.
When you're making transfer, they're not keeping track of your cost basis, they're not keeping track of your holding period, they're not doing any of that. So you almost have to use one of these software programs like coly or Coin Tracker or something like that. And because doing it yourself, when you're, when you're trying to factor in the gas fees, holding period, all it, it's, it's next impossible to try to do it on your own, like pulling it from the Block Explorer or something.
You're almost required to use a software like that, but I always say it still feels like they're in beta testing. Like they'll get you like 90% of the way there a lot of times. So they'll get you close. It'll make it way easier than if you tried to do it on your own, but you still have to go in and red line some stuff being like, oh, it didn't pick up the cost basis there.
It didn't do that, and you still have to make some manual adjustments. Unfortunately that's kind of the, that's the best thing we can do, cuz I'm like you. I've tried out probably a dozen of these things. And again, way better than doing it on your own. Still not a very complete solution, unfortunately. Yeah.
[00:25:37] Ben: Which one is your go to? I mean, I ended up using, I've used Coin tracking.info coin tracker.io. Yep. Coin Lee and then Token Tax are like the past four years. So it's like the evolution of me learning more with this stuff.
[00:25:51] Micah: Yeah. Usually coin tracker coin coin tracking.info. We actually really like if you are like a high frequency trader, just based on their pricing structure, because sometimes we have clients who will use trading bots and different things where they've got thousands of transactions and most of these.
Software companies charge you based on the volume of transactions. So if you went to to coin Tracker with that level of volume, you're probably looking at like five or $10,000 or something pretty obscene to do it versus I think coin tracking.info is like, it caps like four or $500 for the year. Like they're, they're unlimited is is pretty generous.
So those are the three we've had the best success with. I know a few people who really like Zen Ledger. But I, I don't, I, I didn't use that for very long, but it, they're, they're all mostly the same, like any of those top, if you, if you Google like top 10, they're all very similar except for pricing.
[00:26:49] Ben: Yeah.
And I, I think Zen Ledger was like the preferred partner of the irs, which is why I used them. But honestly, like it all feels That's funny. Beta, beta. I mean, who knows? Yeah, so in addition to using a track, Kind of redlining it. What else can people do during the year other than like have the knowledge of, of what's taxable and what's not?
Like does it make sense to keep notes? Does it make sense to like, do an internal audit for tax planning halfway through so you can like tax loss harvest if needed? Like, what other, what other things should we be
[00:27:21] Micah: thinking about? One thing, just one last note on tracking is we tell people please do it throughout the year because it's really easy if you are doing it every week or two or three and cuz then you at least remember the context of what you were doing.
If you try to do it at the end of the year and you've got thousands of transactions and projects you don't even remember anymore, it gets a lot harder. But what we'll do with clients is, Most all of our clients who either are crypto investors or small businesses, we have it to where they're on a service package where we meet with them quarterly and we just check in, see how the year is looking for their total income, and then we can make those maneuvers throughout the year.
We, we'd advise to do that for most people just because, and again, this, this is not for if. You're paddling. If you're just not doing, don't have a lot of income, and you're just looking at this as 10 years down the road, I wanna sell this, you're fine. But if you have any sort of activity, Like you said, tax loss harvesting, when we talked about accelerating income earlier, how toru, sometimes it can make sense to have your income in an entity of some sort, because certain types of crypto income are considered business income, which is subject to what they call self-employment tax, which is both sides of Social security and Medicare.
So, Real, it's just checking in a little bit and then, then you're able to assess the situ, the situation and make those moves. Because once the year closes, we lose about 90% of our maneuvering power and flexibility. That's what was interesting as we've been having people come to us. The, the one thing that has stopped us where clients drop off and don't, don't actually become clients after the consult is.
They don't have the money because they, there's nothing we can do for 2021. We, there's a few things we can try to maneuver and how we categorize it and, you know, if you're doing HFO versus fifo, like there, there's some things we gotta, but you have so much more control so, so, so much more control if you do things before the year ends.
So that's one, that's one of the main things is don't, don't think about in April, think about. October, November, December at the, at the latest. I say this,
[00:29:39] Ben: this is crunch time probably to like realize some of those GA losses and, and make a significant impact. Mm-hmm. Or, or, or like take advantage of these, these turbulent times, I suppose.
Shifting gears a bit here. I hear two diametrically opposed views on the irs. Like, so as we're talking through this, like none of the softwares for retail work, like the way that they should, it's confusing. It's hard. You have to notate all of it. The IRS hired like 90,000 people whatever, A couple.
I mean, the governments are broke, right? So they're gonna try to get money wherever they. Maybe in a bear market's less, less incentivized than to go after crypto people. But like what's the general view of somebody that deals with these people that like the IRS is super on top of it. They're manning up, they're building this crazy AI that's gonna scan all the blockchains and like find these low hanging fruits or like, they're way far behind and it's gonna take them forever to figure this
[00:30:36] Micah: stuff.
It's going to take them a while, but I think the, the issue the irs, at least in my opinion right now, is in, is just in a holding pattern. And we saw that with that Jarret case in, in Tennessee where the, cause the couple of the Tezos tokens, because from the beginning the IRS just really wanted that case to go away so they can kick the can down the road and they haven't issued a ton of guidance even on, you know, there's been no guidance on staking NFTs node.
Play to earn. All these things have been around for a good while now. There's nothing, and my theory on that is that they're, the iris is much happier in forcing legislation that Congress has passed versus coming up with their own interpretation and then having to fight that out in court. So I think given the lack of funding, the Iris has had the complexity of crypto.
Them just really hoping Congress will give them their marching orders instead of trying to figure it out themselves. I think they're just taking this time, getting their AI ready, getting the infrastructure and the plan in place, and then they're gonna go after all these people who aren't reporting it.
And I think people confuse. I haven't been caught yet with, I can't be caught. And right now I think the IRS. It's just sort of preparing themselves. And if you have people who once, once they deploy all these agents and ai, it's one thing if you report reported all your income but maybe didn't do it perfectly right?
Cuz there's no guidance. It's another thing if you're not reporting it at all. So I think some people are gonna be the people who think, oh, I do everything on defi. Everything's on meta mass. They can't track. It's not on a centralized exchange. They can't figure that out. Well, they go back one or two steps to a platform.
You have KYC and see what you're, you're doing. They're going to get letters or get audited from multiple years. Once they get that deployed, they're not just gonna look at going forward, they're going to look back and there's gonna be some people who are going to really, really get hammered hard when that happens.
[00:32:41] Ben: Yeah, I mean, it's important to remember that the blockchain is public, transparent and permanent, so they literally have until the end of the blockchain to figure these things out, which is the benefit of a blockchain. But it's also like a security privacy dystopian disaster if you haven't taken proper like steps.
This stuff is super, super helpful. I have some q and a from Twitter. Right. Cool. As, as, as it always goes. So there's I think what we've covered, we'll, we'll cover a lot of these, but one that comes up a lot is on NFTs. So non fungible tokens have been huge in the past year. But I hear that, that they're not all taxed the same, and their taxation depends on their utility.
So collectible versus non-collectible. So how should people think about this differences if, if that's correct and, and like think through this. Yeah.
[00:33:35] Micah: Well, That's been, that's been my contention all along. And there's not a lot of other people who talk about that because the limited guidance, there's no actual guidance from the irs.
But what you'll see most articles talk about is that NFTs should be taxed as collectibles. That's, that's the sort of consensus theory right now, and I think for a lot of NFTs that's gonna be true. If you've got an APE or a crypto punk or one of. There's no, I guess ape is becoming a little bit more, they're, they're launching different stuff, so it's not as good of an example as it used to be, but they're not really providing you any utility.
You're do, it's the same as if you were purchasing a physical collectible. You're, you're purchasing it for it's rarity and hoping it appreciates in value, but it's not doing anything. It's a piece of art. But if you look, NFTs can be almost anything. The, the reason the NFT exists can. There. There's just this really, well, I don't think we've even scratched the surface of what they could represent, because I'll always give the example, I'm in a Discord server where to get in the server, you have to buy the NFT and they verify that, that it's in your wallet.
And that my membership in that expires at the end of 2022, and now I'm have to buy another n ft if I want to stay in the group. Well, yeah, I'm buying an an asset theoretically, but what I'm really buying is the membership and there's a finite term to it. So treating that the same as a collectible n ft, it kind of misses the point of what the NFT is being used for.
And we'll say the same thing. If the Metaverse ever launches Metaverse NFTs or, or play to earn games because there, there's there's NFTs for all kinds of NFT games, but I think the best example are it's gonna be some sort of MMO RPG games where, you know, a World of Warcraft scape style game where you can buy land a building.
A piece of art to hang in your house. A sword that that degrades, a pickax, that degrades and all of those, if they were the real world equivalence, would be taxed very differently. The land went depreciate, all the building would depreciate probably over 40 years. If it's a, if it's a tavern or something, the, the sword and the pick X, you might just expense because they're so much smaller and they've got a very finite life to.
So I think what's gonna happen is that the irs, whenever they do issue guidance, they're probably gonna say that you can amortize them under what they call section 1 97 of the, the tax code. And that defaults to 15 years or the, the use, if the useful life is less, you can prove it, it'll, it will amortize over a.
Longer, a shorter period, but I think they're gonna start with looking at, at it as an asset and not particularly favorable terms to try to expense them. And I think there's gonna be a lot of litigation that comes up over that when people do get audited and the IRS tries to dis out and they say, yeah, it's, it's an nft, but it gave me membership to this group for two months.
That's not, it's worthless now. So I think we're gonna have a lot of that just. NFTs can't. We're already looking at where you've got some tokenization of assets that real assets that are coming up. I think that's what we're gonna see, especially with NFTs, is a lot of contention over how they should be taxed.
And I think it's really going to go based on the use case of each nft. Yeah, that
[00:37:10] Ben: makes sense. So I, I just did some quick goo Googling, but a collectible is tax at 28%, and that's even, that's at long term. So anything less than a year is still ordinary income. So the difference there would be quite substantial if you hold it for more than a year and you're taxed at 15 or 20% versus 28.
Right. Interesting. So NFTs are not collectibles. They have utility. That's, that's the, the drumbeat we
[00:37:35] Micah: have to be, I mean, that, that, yeah, that's what, that's what you really want. And the way you, and it's gonna be, this whole thing's gonna be so fascinating because the regulation that comes is going to change the space as, as we get more court decisions, more guidance, you're going to see the, the space pivoting and changing the way their projects work to try to fall into these more.
Favorable categories like, like NFTs. If it's just a piece of art, I think you're gonna see NFT projects that start trying to show some utility into the project to, to avoid that categorization. Well, not just
[00:38:11] Ben: that categorization, it's a bit of a meme at this point of how much utility you're in Ft. Has.
So we'll just start highlighting those. But then that probably like treads you more towards a security token. You know, there's, there's pros and cons of everything. It's,
[00:38:26] Micah: it, it's gonna be, it's, the whole thing's gonna be really fascinating because as the government tries to get their hands around this and they pass legislation or guidance, If they make it overly broad, it becomes borderline unenforceable, un unenforceable.
But if they make it too narrow and when it's narrow, that's much easier to enforce. You're gonna have projects just mo maneuvering to get around that classification. So they're gonna have to try to find this sweet spot of co covering the not being so broad that they can actually go and enforce it, but broad enough to where.
It's still gonna encompass all the, the projects that they, they intend for it too. Yeah.
[00:39:09] Ben: Interesting times indeed. All right, so also on the NFT subject had a couple questions like, I mean, so with NFTs, if you're kind of in this space, you end up buying a bunch. A lot of them go to zero. Effectively, there's no market, so like you want to be able to.
Recognize this loss without necessarily having to sell it. So the first question would be like, how to do that without like, you know, selling it or sending it to a sale contract. And then the other one would be similar. You know, I have this NFT that I bought. That I want to gift to somebody. So how can I report that as a loss if it's, if it's below the value or, or how to think through these things, right?
[00:39:53] Micah: For you to be able to take the loss, you have to show that you have permanently disposed of the assets. So, and that, that gets tougher with NFTs than it does with crypto, because if you're just doing tokens and it's down 99%, you can sell it and buy it right back. With an nft, depending on, it's gonna be hard for you to get that specific NFT back.
You might be able to buy another one within the same project, but you're not. It just the lack of liquidity within NFTs, it's much harder to get the exact asset back, but to to show the loss, you have to dispose of it either by a sale or if the project is pretty much completely dead. You send it to a Noll address that you can't retrieve it.
But unfortunately, that's the only way to get the loss. So you have to, there has to be a true transaction. In terms of gifting that, that's the same as any, any other property. It's, it doesn't really come into play unless I think the gift tax exemption is $16,000 this year. Unless it you, you can gift a person $16,000 up to $16,000 without any tax consequences.
So if you're just wanting to give, give it away. You, you can. Do that.
[00:41:05] Ben: You would basically have to keep track of which one I, I mean, cuz you could send it to a null address, like a burn address and recognize the loss. But if you like send it to a friend's address because you're gifting it and it has zero value, then you know you could.
Note that one. Cuz it won't, it will show up as a transfer, not as a sale in the software, but, so you have to keep these notes, but also if you gift it to somebody and it still has a value of like under 16 k, you can use that to like offset some gains as well, right?
[00:41:37] Micah: Yeah. If you are actually showing that you, you were never getting ownership of it back, you don't want to get cute with that and be like, yeah, I sold it to my buddy or gifted it to my buddy.
It needs to be that you really are relinquishing control of it.
[00:41:54] Ben: So that's, So on that buddy's income statement, if, if, if I, so this is where my head goes. So I give you a, a, a mutant a that like, looks like this and I write off 15 K on my thing and then you on. How, how's that treated on yours? And then say, you gift one back to me of like, it's also unique,
[00:42:18] Micah: but they're very different, right?
Yeah. I mean it, the term that we always use is that it needs to be what they call an arms length transaction. It needs to be a transaction that actually makes sense with an unrelated third party at the point when you're doing stuff like that, like, yeah, it's on the, it's on the block chain like that, but.
If you get audited, it's again,
[00:42:41] Ben: public transferring and permanent, a pretty, pretty PO
[00:42:43] Micah: choice to do it. And I'm not, I'm not a super conservative on, you know, we're, we try to play the gray area and find creative ways to structure things. So I'm not opposed to creative thinking and trying to, you know, Push the envelope a little bit, but again, you don't, it needs to, it needs to make, make sense?
Yeah. Well, I, I,
[00:43:05] Ben: so how, if I gift you a mutt ape and it's worth 15 K, like I take a minus 15 K on my taxes, but like for you, you've just been gifted an asset that has a value of 15 k. Yeah. For
[00:43:18] Micah: the, how does that work for you receiving it? There's no, there's no tax consequences until
[00:43:22] Ben: you sell it. So you sell it at, at, at.
15 K you have a cost basis of zero basically, cuz it was gifted probably. Right. Okay. Yeah, that makes sense. Another question that came up was so shifting gears a bit is like income streams that might be subject to self-employment tax. So network staking, delegated staking, validator, stuff like that.
[00:43:45] Micah: Yeah, so mostly the things that would be subject to self-employment tax, and the only one that Iris has issued specific guidance on is mining income. They've said explicitly that mining income is business income, so the only thing that is close to that is if you're a node operator, at least as they exist now.
So our contention is that node operators and mining operations are both gonna be subject to self-employment tax. If you're just like, if you're just delegating your tokens, I think that falls much more into sort of like you're receiving dividends. There's not the amount of work you have to do, there's not the infrastructure, but, but nodes and mining, self-employment tax, so it can make sense to have your mining income in an LLC and have it taxed as either in s, usually in S corporation, sometimes a seed corporation can make sense because by doing that, you're, you're bypassing the self-employment tax.
[00:44:37] Ben: That makes sense. And you can see with these questions well how this gets so confusing for people. Yeah. So I totally get it.
[00:44:45] Micah: Well, even with, with nodes, we've even noted that. I think it's, there's a fair num, there's a few nodes out there that are basically software licenses or NFTs, like masquerading as nodes like, because strong nodes I think was a good, good example.
You weren't actually setting up your. Running it on your own computer or ORs, you were just, they were, you were renting the server space theoretically from them and just paying them a fee. That's not the same level of complexity and work to be, be a business activity. So most, I'd say real node projects absolutely fall into the business income bucket.
But there's a handful of, you know, you put air quotes nodes there that, that probably don't.
[00:45:32] Ben: Yeah. Yeah. The other, the other one that was super highly relevant in 2021. So in crypto we do this thing called a retro airdrop which you know, in layman's terms is just free money for people that had used the, the ecosystem.
Yeah. But like, the concept here is you get. Bunch of tokens sent your wallet. So obviously if you sell those and they have a value you have a taxable gain and your, your cost base is zero these things and makes sense with your holding period. All, all of that stuff makes sense. But there's this funny thing, and actually, well, there's this funny thing that like the price in which you got them or claimed them can be, can be different.
So I. If, I guess, if, if, if you receive these tokens and then you claim them, wait, I'm actually confusing
[00:46:31] Micah: myself with this whole, this whole question. I think I know where you're going with this though. The, the way, again, weirdly enough for all the things Iris hasn't issued guidance on, they, they've issued guidance on airdrops and hard forks they have.
And the reason for that, they have weirdly done. The reason for it is that back in. They, they issued it Bitcoin in a theory, Bitcoin cash in 2014 that they accounted for. At that point, 90% of the market cap, of the whole crypto market, and both the theory and Bitcoin had hard forks in 2014. Five years later, the IRS finally issued some guidance and they said that if you receive a hard for, there's a hard fork that results in an airdrop and you receive a new token, then that income is taxable to you upon.
So if you got some Bitcoin cash or Ethereum Classic, whatever the value was as of the date that you were able to get, again, that dominion in control, when you have full unfettered access to it, that's whatever the fair market value is, that's what you claim as income. So people will mess up and not realize they need to claim that income.
The other thing that they'll not realize is that your cost basis for that token isn't, isn't zero. In those cases, it's actually whatever income you had to claim on the airdrop. So if you get $500 worth of a token, you gotta claim $500 of airdrop income. But then when you sell it, your cost basis at that same $500, so you you, if you sell it for 500, you don't have a capital gain.
Yeah, cuz this
[00:48:03] Ben: is where it gets confusing. I mean, there I, I have some buddies that had scam airdrops sent to them and like their tax software, when they ran it through, you know, they're looking at them monthly and it's like, In August, I have a 50 million gain. Like what on Earth? So you look into it and you're like, oh, I got 50 million tokens of this scam project that was registered in $1 for, for some reason I'm too scared to even touch them on my in my wallet because like you just ignored.
Could be the delicious
[00:48:37] Micah: could is those are,
[00:48:38] Ben: but, but then, you know, looking back, it's like, You've gotta keep these notes that you eliminated a 50 million gain of this scam token because a cursory look at the blockchain using normal price. Oracles says that you made 50 million that month, which is very significantly different.
[00:48:56] Micah: think Yeah. Oh yeah, absolutely. I mean, you just. Just ignore those because obviously they're not worth anything. So you got airdrops something with $0 of value regardless of what the, the block explorer wants to say. But, but it is interesting just because even within, and there's just so many little variations, even within airdrops, when you claim as income varies a little bit.
Largely it's based on the mechanism of claiming. And the and that's largely sometimes based on the, the block chain you're on, because if you're on Binance Smart Chain, there are some, there's a lot of s coins on that, and some of them will just give you partner projects. They'll just drop a piddly amount in, in your wallet.
Well, those. You have full, they immediately put in the wallet. So you have dominion control, you have full unfair access to sell it. So that's when you need to claim the income. But if it's on Ethereum and you have to go through and actually manually claim the token, in most cases, that's when you claim the income.
Cuz that's when you actually received it and exercise that control over it. Mm. So even with that, there's some variation that comes into the exactly how it's set. Which is, which makes it all, all the
[00:50:10] Ben: more difficult. Yeah. It's, and I mean, for people listening, you know, this is just your address on one blockchain, and you can have, you know, that same address across multiple EVM compatible chains.
You know, I have 15 different blockchains in my or side chains, L twos in my meta mask, you know, so that's like replicated across all of them. Which explains why you have such a disaster. One other question I had is regarding F bar. So crypto, which is not currency, which is an asset held on an exchange that is overseas.
Should this be reported on, on your
[00:50:48] Micah: F bar? Not at this point, that's probably going to change, but the very limited comments we've gotten from the IRS on it is that it is not subject to it, but basically taxpayers should prepare for that to be the case. There was even one IRS agent, I think he did an interview with tax notes and they even said, you know, it might not be a bad idea.
If you want to just be extra compliant, you can go. There's no downside to do to doing it, but right now it's not required. So I think that will, again, as, as this becomes more mainstream, as the government finally kind of figures out how to get their arms around that, they've hinted that they're going to try to get that in included.
But right now you don't have.
[00:51:33] Ben: For listeners, sorry, I should have defined this. F bar is foreign bank and financial accounts. So this is what you have to report if you have ownership or like jointly control an account outside of the us. So I lived outside the US for 10 years, so constantly, like any sort of bank account of it has a.
Value over $10,000. Yeah. Or if you're working for a foreign company that has, and you have director control on you know, 150 bank accounts like I once did, you need to report all of those, which is super fun for the, that's fun for the treasury department. That's, yeah. Yeah, that was a surprise. But you know, where things are going is like if you have money on finance, which is Donald South and probably in Malta, but not in the us.
You might need to report those going forward, but currently you did not, which is which is interesting, but we're definitely going the way of reporting. So . Yeah. Surprise. Micah, this has been super, super helpful. Thank you for going through all of these basics things to remember and then like the q and a section which I think was particularly helpful, where.
What else do you wanna leave my listeners with and where can they find out more about you and frame cpa?
[00:52:42] Micah: Yeah, so it, it's a cliche, but especially in this space, in volatility, we, you know, talk about announce of prevention is worth a pound of cure. Be proactive during the year and don't wait till the year closes to try to figure this stuff out retroactively, make sure you're making, making this part of your, your ongoing investment strategy, dealing with the tax side.
If people are looking to reach out to us, they can go to crypto tax cpa.com and send us a note there. We also have a book that's the digital version's free on Amazon right now called Decrypt Crypto Taxes, and we structure that largely every chapter's pretty much an FAQ that we've got. And so based on the chapter title, you can, you'll be able to go and get some guidance on the general idea of how each bucket and each activity would be taxed.
So, I, I encourage them to, to do that because, It's better than a lot of what's out there
[00:53:37] Ben: now. Oh yeah. And thanks for making that free as a resource and I'll, I'll link up all these things in the show notes, but really appreciate it, Micah, and appreciate having you on. There you have it.
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