332: How to Use Tax Law to Benefit from the Cryptocurrency Bear market
Buck: Welcome back to the show, everyone. Today, my guest on Wealth Formula Podcast is a self described crypto and NFT obsessed CPA who’s a best selling author who’s been featured in Nasdaq, Forbes and Money. It is Micah Frame. Michael, welcome to welcome your podcast.
Micah: Thanks for having me. Really excited to be here.
Buck: Yeah. So let’s start kind of like with your background a little bit. I mean, how did you how do you find yourself becoming sort of an expert in the cryptocurrency space?
Micah: Mostly by accident. Because what I’ll say is that I bought a little bit of crypto like everyone else did in 2017 during the initial coin offering craze and the three or so grand that I threw in there very quickly became $1,000 because the market crashed pretty quickly and I mostly kind of forgot about crypto until somewhere around. Say. 2020.
Buck: Like everybody else had.
Micah: The market had recovered and that three grand that had turned into one had turned somewhere into like 6000. $9,000. So around that time, I had a client tell me about a Node project that they were involved in. And that project was the first time that I really understood the use case and the utility of a specific crypto project. Up until then, it had been, well, smart people say blockchain is a big deal, but I get that blockchain is a big deal, but why is this specific token valuable? And that project was the first one where it just sort of clicked. So combination of doing it as an investor myself, and then also most of my clients are online business owners, that’s the majority of the rest of our practice. And since they’re sort of tech centric anyway, more and more of them have been getting involved in crypto. So as we were trying to figure out the questions for ourselves or for our clients, it became really clear really quickly that there’s nothing out there. The guidance is almost nonexistent.
Buck: That’s right. Well, let’s kind of jump into it then. I guess the broad question is if you want to just describe in general for those who don’t know how crypto trades are taxed.
Micah: Yeah. So crypto trades. And this is one of the things that we run into the casual trade or won’t realize is that for most trades that we execute, there’s going to be cash involved. So if you sell a stock, you’re going to receive cash for that. So what people will think is that if they’re doing what you call coin for coin trades, so you’re trading your bitcoin for ethereum or for salona or some other crypto token. They’ll think that so long as you don’t cash it in for a fiat currency like US. Dollars, that you don’t pay tax on it. And unfortunately, that’s just not the case. The IRS has specified that if you’re doing coin for coin trades, each one of those trades is its own taxable debt.
Buck: Right. And my understanding was actually because I was in cryptocurrency in 2017 and stuff. And that ruling or that clarity was laid down back during that time before that actually. It seemed like this actually was the case that this might have been a change from the prior taxation. The way the IRS viewed it. Or maybe they just didn’t view it at all and they finally came on with some sort of clarity what happened there?
Micah: Yeah, to my knowledge, they just had not issued any guidance at all. And then they finally did and said that these coin for coin trades are taxable. But the problem is that they’re always like five plus years behind on issuing their guidance. Because what did happen was when the Tax Cuts and Jobs Act, the 2018 tax reform that happened, they specified in that very specifically that you can’t do that crypto or intangible assets aren’t eligible for 1031 like kind exchanges. They said for 2018 onward that you cannot do exchanges. But people ask, okay, well, that’s 2018. And later, I think what you might be referencing is that people ask, well, what about before tax reform happen? What about for 2017 and prior? Can we do 1031 exchanges? And the IRS did an analysis, and this shows you how far behind they are. The three tokens they did were Bitcoin, Ethereum, and litecoin. Those were the big three that they did analysis of. And they showed that there were differences in each token to say that they’re not substantially the same and thereby even prior to that clarification 2018, that you can’t do a like kind of exchange, you can’t do a deferral for trading tokens for tokens.
Buck: So let’s get one thing I think would be useful for clarity because I think it’s important because it’s not, as you mentioned, 1031 exchanges are not allowed, but it is considered cryptocurrency, unlike stocks, is considered personal property, right, personal as opposed to portfolio. And that makes a big difference when it comes to things like wash sales and things like that. Absolutely. Do you want to talk a little bit about that? Yes, you can just sort of summarize I just kind of glanced over it, but maybe you can kind of give us the one on one on that.
Micah: Well yeah, I mean you hit on the main difference as it exists right now, at least for regular trading income and that’s that the IRS, at least for now, considers cryptocurrency to be property, not a security. And since it’s not a security, it’s not subject to what they call the wash sale rules. And the way the wash sale rules work is that the IRS says that if you sell security but you buy it back within 30 days, then if you sell that security for a loss but buy it back within that month period, you’re not allowed to write that loss off on your tax return. The basic logic being that if you buy something and immediately purchase it back you’re not really disposing of the asset, you’re not really selling it. So we’re not going to let you take that tax right off. But right now at least cryptocurrency is property and since it’s property it’s not subject to those wash sale rules. So now that we’re in a bear market right now that’s one of the main strategies we’re working on with our clients is tax loss harvesting where they’ve got these underwater crypto positions and saying okay, go ahead and sell the token, you can buy it back ten minutes later but that at least realizes the game.
Buck: You’re locking in the losses for the year. So why not? Right? Yeah, absolutely. That’s huge. And hopefully if that’s one thing that people who are investing in cryptocurrency get from this particular podcast, that is something that could save you a lot of potential money because I know there are some fairly significant cryptocurrency holders in our audience and we’re in a bear market so I feel your pain. And some of us who have been talking about cryptocurrency have actually referred to themselves as professional tax loss harvesters at this point instead of cryptocurrency investors. Let’s talk a little bit in more in depth now some of the issues, other ways of creating income in the cryptocurrency space. So for example, staked tokens, how are those taxed? General categories, right?
Micah: Yeah. So there are two general categories with staking. One is if you’re operating as a node operator or node validator and that income is more analogous to mining income and mining income is business income. That’s the category that the IRS has thrown it into. But for most of us we’re not going to be operating nodes. Most people are just going to be staking as delegators. That’s just the terminology. You’re delegating your tokens to one of those node operators or validators and with those, those are currently at least are taxed essentially as dividends because it’s just a reward you have for holding the token and you’re receiving more in kinds tokens. There’s litigation ongoing that’s being challenged though right now and there’s a few things I should say on that. One is that the IRS hasn’t specifically issued guidance on staking. Yet the general thought process and the theory behind staking income right now is based on the guidance they issued on air drops and hard fork income. So that’s the one thing. The other thing is that there’s a case right now in Tennessee, I think it’s Middle District Court right now, called it’s Jarrett versus the United States of America, where there’s this couple who had Tesla’s tokens and they claimed this income and then sued the IRS claiming that it should not have been taxable income until they actually disposed of the tokens. So they’re trying to force the issue right now either, ideally for staking income not to be taxable income until you sell your tokens, but at the very least to get some clarification and concrete guidance from the IRS on what you’re supposed to do with staking income, because right now they’ve just been pretty silent on it. And I seem to be kicking the can down the road, just waiting for Congress to pass legislation instead of coming up with their own interpretation.
Buck: Quick question, you mentioned mining, and this is relevant to potential an opportunity that our investor group is going to be looking at in the near future. And with mining, the one thing that I’m a little unclear about, I’m guessing I know the answer. But just for clarity, when you mine, presumably based on what you say you’re producing bitcoin and that bitcoin that is produced, is it taxed at the dollar amount that it was at that moment that it was produced?
Micah: Yes. Okay. Yeah. The phrasing and the sort of the term of art that becomes really important is they talk about when you have dominion and control over the asset. So that means that when you have receipt of the asset and also you’ve got essentially unfettered access and utility to it, to where you can use it, you can dispose of it, you can do whatever you want with it. So when you ever see and you’ve got full control of the asset, that’s when the taxable event triggers, and you’re doing it at whatever the fair market value of bitcoin, Aetherium, whatever your mining was at that time.
Buck: Okay, and just for clarity, again, in terms of the air drops and hard fork type, when you get those kinds of tokens, those right now, we should kind of look at them as dividends.
Micah: Yeah. Whenever you’ve got full unfettered access, that’s going to be taxable income, and essentially you put it on the return as miscellaneous other income, but for all intents and purposes, it’s dividends.
Buck: So let me ask you this. You mentioned crypto does not qualify for 1031 exchanges, and that’s because it’s not a business and it’s not real property. Correct?
Micah: Yeah, since it’s intangible assets. And I think they did this because when they came up with this 2018 tax reform, it was right after the ICO craze and crashed. So I think they anticipated people wanting to defer those games. So they just codified it that it’s only for real property that you’re allowed to do 1031.
Buck: But the question I have is because it’s still personal property, would it still be eligible for the bonus depreciation rules? Like, in other words, I’m an investor. Say I’m an investor and I’ve got crypto gains and I have real estate losses or losses from a business, I should be able to offset that, right? Can I use depreciation to offset gains from cryptocurrency because it’s a personal property?
Micah: We haven’t gotten any indication that that’s the way they’re going to treat it. Now what this sort of gets into, you’re not really going to depreciate or amortize tokens, but what that does get into is NFPs because NFC are such a wide array of what the utility behind the NFT is and what the use cases for the NFP. So again, unfortunately we have no concrete guidance from the IRS on NFC. But for most intangible assets you fall into one of two categories. One is that you don’t advertise it at all, it just sits there at face value and you don’t expense it or do anything until you dispose of the asset. The other is what they call section 197. It’s amortizable NFT for tangible assets. You depreciate them over time. Same basic thing within tangibles, but it’s called amortizing. So for those sections, I hate getting into just jargon, but for those specific NFCs that do amortize, they amortize on the lesser of either 15 years or the useful life of the asset. So if you can prove that the assets useful life is less than 15 years, then they’ll let you use that shorter life. So assuming the IRS concedes that NFPs and these intangible assets should be allowed to be amortized, where we’ve gotten more flexibility? Bonus depreciation is not really in the cards right now, but you can have it where you say, hey, this NFT that I bought, it really only has a useful life of one or two or three years and then you’re able to amortize that over a relatively short amount of time.
Buck: Got it. How do you recommend for your clients right now to track their cryptocurrency activity? As you know, it gets very complicated, particularly for people who are dealing with more than just bitcoin and ethereum and then you’ve got these decentralized, decentralized dows and all this kind of stuff that it gets very, very tricky. So for your clients, how do you recommend they track crypto?
Micah: It’s a nightmare, there’s no real way around it. So what we tell everyone is you pretty much unless you’re doing everything just on your coinbase account or you’ve got a very simple portfolio that’s basically on one centralized exchange. But if you have any sort of expansive crypto activity at all, you’re pretty much required to use one of these coin tracking software, be it Coin Lake, Coin Tracker. There’s one that we recommend for people with a really high volume of transactions called coin tracking info. Reason being is that if you’re using a trading body or high frequency trader, it’s much cheaper than the more mainstream ones would be. But even with those, we say that gets you about 90% of the way there. I know it’s not a simple issue to fix because otherwise these companies would be fixing it, but they still feel like they’re in beta testing a little bit right now. It still feels like they’re designed for simpler transactions and activity versus the way people are trading and investing now. So what we end up having to do is you use the software, it gets you most of the way there, but then you end up still having to go through and redline the report to modify the things that just are not being captured properly.
Buck: My gut on this is use those things, do the best you can. It’s going to be a lot more than most people are doing. And certainly from the standpoint of the IRS, it’s like, how in the world do they go back and reconstruct it? So do the best you can, be honest.
Micah: And that’s all you can do at this point. Because unlike traditional investing or just even things that are analogous in business, we don’t have the guidance that we would normally have, and we also don’t have the sophisticated tools that you have and these things that have been around for 50 or 100 years. So, like you said, a lot of people are still sort of in this idea of, well, it’s on my MetaMask, it’s on D Five. I don’t need to report it. The Iris is never going to find out. So if you’re reporting all of your income and you’re making a good, honest faith effort to report everything and report accurately, that’s all you can do right now. And our thinking is that the IRS is going to be if you do mess up, the IRS is going to be reasonable and lenient. If you’re able to show that you really were putting your best foot forward, to report everything properly.
Buck: It’s very important. I think that’s an interesting thing because of the nature of this stuff. I met a guy in one of these conferences who had several million dollars, we’re talking 20, $30 million of Bitcoin, and it’s all sitting in D Five, but he doesn’t report anything. Nothing. I mean, those are huge dollar amounts, right, but his whole point is, how are they going to ever know? It’s defy, right. So at the end of the day, somebody will probably figure out how. Right? That’s really what comes down to it’s. Like you’re sort of challenging that and risking jail time.
Micah: Exactly. And it’s also one of these things too, where I’ll never claim that there’s not some way that I’m sure you could hide all this from the IRS. I’m sure you can use Manero or some privacy coin and you layer it with tor
Buck: But then you’re a criminal at that point.
Micah: And unless you’re doing for most people like, well, it’s on MetaMask, how are they going to know? Well, most of us aren’t going through all those steps, so all they have to do is rewind one or two steps to a platform where you’ve got KYC, right. It’s going to be really easy for them to say, okay, well, here’s your crypto.com account, and then you keep sending money to this other wallet. They’re not idiots. They’re going to be able to tie it back to you. And I think what it is is that a mix of the IRS not they’re really trying to kick down the can down the road, so far as we can tell, until Congress gives them guidance. So I think in the meantime, they’ve just been kind of making their tools more sophisticated. They’re getting the framework in place, and then now that there’s all this additional IRS funding, maybe they start to use that towards enforcement activities. But they’re going to be able to figure this stuff out and they’re going to go back retroactive. So do the best you can, be honest, and don’t get too cute with it, because they will. They will get you.
Buck: This is one of the spaces that they’re very serious about right now. Isn’t it a felony, right, literally, to not admit that you own cryptocurrency on your tax return?
Micah: I know that there’s the check box on where you have to disclose on every return. I have not looked into it. That’s a felony. I think it is.
Buck: I’m pretty sure that’s what Tom Wheelwrite was saying something, but people can look it up. If I’m wrong, let me know, but it’s bad. One other topic that I think I’d heard a little bit about, but really didn’t hear it clarified in any sort of meaningful way is, well, at the end of the day, with bitcoin, there are people who are accepting bitcoin for payment, people who are buying things. With Bitcoin, there was some question of whether bitcoin transactions of a certain amount would be considered taxable events or not. Do we have clarity on that?
Micah: Not yet, but I can’t remember what the name of the legislation was. But there have been a few iterations of proposals. The most recent one was that if you’re disposing of cryptocurrency and it’s under $200, then that’s not a taxable event. Because right now the issue you’re running into is that cryptocurrency is considered property. So even if you’re using it on a crypto debit card or something and you’re swiping for $5 at a Starbucks, that’s a taxable event that you have to account for.
Buck: And an accounting nightmare.
Micah: It’s a nightmare for everybody. Right. And I imagine what they’re going to need to put some sort of provision in there to where they look at the aggregate number of transactions or the aggregate dollar value because otherwise you’re going to have people who do $10,299 transactions selling their crypto to avoid the capital gains. But there’s definitely movement on that because crypto already has enough issues of functioning as an actual currency. There’s already a bunch of hurdles with that. If you tack on the fact that every time you swipe your card or send something now you’ve got capital gain or loss, it just makes it so much harder to utilize it as a payment method.
Buck: Do you feel like we’ve covered most of the major topics or is there anything we’ve left out with regard to just your typical cryptocurrency investors?
Micah: I think so because for most people you’re going to have staking income. You’ve got your trading and then works drive. Yeah, you’re going to have just random drops. Then you’re also going to have, if you’re on a centralized exchange, just interest deposits. But those are sort of the core things that I’d say 80% of crypto users are getting involved in. There’s a bunch of other fascinating and more niche situations but in terms of what most people are dealing with, I think those are the big ones.
Buck: You have a couple of books up but they’re more related to small business. Do you want to mention those real quick and where people and what they’re about and where people can get them?
Micah: We did launch another book about a month ago specifically on crypto taxation. It’s called Decrypting Crypto Taxes and it’s the complete guide to cryptocurrency and NFT taxation. That’s on Amazon right now and the digital version of that is free. We’ve got a promo going.
Buck: Okay, is there a website that you get that at or is that an Amazon?
Micah: That’s just on Amazon. Okay. And we’ve got on Barnes Noble and ibooks, it’s on most major retailers.
Buck: Do you do consulting as well? Are you only dealing with your clients that you deal with on a sort of global tax service?
Micah: Well we do. Most of our consulting is done with the clients where we’re doing their tax return and we’re more actively involved just because we can. That’s where we provide the most value because so much of it becomes the totality of what you have going on in not only your tax situation but your investment strategy, your balance sheet. So we provide a lot more value when we really have a good pulse on all the stuff you have going on and then we’re able to sort of synthesize all of that together. So we’re always happy. If someone wants to do an initial consultation, we’ll give them some guidance but it’s definitely not as value added as the ongoing planning.
Buck: How do anybody get in touch if they’re interested?
Micah: So if you’re a crypto investor, our website is cryptaxcpa.com. So we’ve got our contact form, most of our resources and also just a breakdown of how we function. If people are having questions and think they might be interested.
Buck: Michael, thanks for being on Wealth Formula Podcast. This was really useful information for everybody.
Micah: All right, perfect. Thanks for having me, man.
Buck: We’ll be right back.