By Lynnley Browning and Camila Russo
(Bloomberg) --Investors in bitcoin and other virtual currencies would lose a lucrative tax break under the Republican tax bill that’s on its way to President Donald Trump’s desk.
New limits in the bill would bar cryptocurrency owners from deferring capital gains taxes when trading one type of virtual currency for another -- effectively closing a gray area in the tax code, experts say.
Those gains can be considerable. Bitcoin, which had an initial price of less than 1 cent when it first traded in 2010, was around $1,000 as 2017 began and surpassed $19,000 this week, at least briefly, before paring some of the gains. Many enthusiasts jump between bitcoin and a long list of similarly volatile competitors, such as ether.
For investors who hold the virtual currencies, “the bill is bad news,” said Kelsey Lemaster, a tax attorney with Goodwin Procter LLP. “Every time you trade one digital currency for another, one token for another, it’s going to be a taxable event.”
The change might not deter traders, who have been leaping into cryptocurrencies without researching what they are -- let alone their tax implications, said Brian Kristiansen, a partner in the digital currency services practice at Friedman LLP.
Under current law, such trades have been protected under a provision that allows investors to defer capital gains taxes on so-called “like-kind exchanges” -- trades that traditionally have been staples for investors in real estate, art, racehorses and aircraft. The deferral applies when owners of such property swap it for other property of a similar kind, typically within a 180-day period.
Increasingly, traders concerned about increased government oversight have sought to move between virtual currencies to take advantage of the like-kind deferral. Now, though, the GOP tax bill would restrict the break to trades of domestic real estate only.
“That’s only for real property now, and ‘crypto’ is about as not real as you can get,” said Friedman’s Kristiansen.
That change goes into effect on Jan. 1. After that, exchanges of cryptocurrencies “would be subject to tax at the time of the exchange,” said Lisa Zarlenga, a tax attorney with Steptoe & Johnson LLP.
Investors typically have to pay taxes on their short-term capital gains at their individual income rates, which will top out at 37 percent next year. The preferential long-term capital gains rate -- which tops out at 23.8 percent -- is owed when such assets are sold after a year.
With its new limits, Congress addressed a quirky section of the tax code. The rules for like-kind exchanges, first enshrined in the code in 1921, have never applied to stocks, bonds or other securities, and they contain some fine distinctions about what constitutes “similar” property. For example, a beef cow cannot be swapped for a dairy cow. Paintings can generally be swapped, but it’s not clear that a Rembrandt could be swapped for a Jackson Pollock, according to a 2012 article in an American Bar Association trade publication.
The sheer variety of virtual currencies -- all running on different blockchains, the encrypted networks that record transactions -- has always made them somewhat awkward candidates for the like-kind exchange deferral, Lemaster said. A so-called utility token, like Filecoin, is very different from “true cryptocurrencies like bitcoin and ether," he said.
In March 2014, the I.R.S. declared virtual currency to be property, like gold or real estate, and not currency, for tax purposes. That distinction makes it subject to capital gains taxes. Despite the definition, the tax-collecting agency hadn’t fully defined how -- or whether -- cryptocurrencies could be used in like-kind exchanges.
"There’s always been a question under current law as to what types of currencies can be exchanged and qualify," Lemaster said. "The conservative view is that it doesn’t qualify."
Most cryptocurrency investors have ignored that legal fuzziness, and taken the approach that trading a stash of, say, bitcoins for litecoins, qualifies as swapping one form of property for a similar one. “People have probably foot-faulted all over the place,” Lemaster said.
Once a swapped asset is actually sold, the seller would owe capital gains taxes, at a tax rate that depends on whether it was held for more than a year. While that may take a bite out of some investors’ gains, it’s good for cryptocurrencies in the long run, said Ryan Losi, who leads the international tax practice at accounting firm PIASCIK.
More defined regulation will mean that digital assets are more easily accepted in the mainstream, Losi said.
“As this fledgling type of payment gets older and more adopted, more scaled, eventually it will get regulated,” Losi said in a telephone interview. “More and more people will come to accept it and agree with it, even if early on it is very speculative.”
Likewise, the new law is unlikely to damp interest in listing exchange-traded funds related to virtual currency, said William Rhind, the chief executive officer of GraniteShares, an investment company that filed forms last week seeking permission to list two bitcoin ETFs. More than 15 bitcoin-related ETFs have been proposed since 2013.
Rhind said existing rules already prohibit securities from being used in like-kind exchanges. “I don’t think it’s relevant,” he said.
To contact the reporters on this story: Lynnley Browning in New York at [email protected] ;Camila Russo in New York at [email protected] To contact the editors responsible for this story: John Voskuhl at [email protected] David Scheer