Seward & Kissel Releases Comprehensive Whitepaper Detailing the Complex Taxation of Cryptocurrencies and Digital Assets

April 9, 2018

In a Whitepaper relating to the taxation of cryptocurrency, Jon P. Brose and Brett R. Cotler of Seward & Kissel’s Blockchain and Cryptocurrency Practice discuss various aspects of the United States Federal income taxation of transactions involving cryptographic and digital assets, such as bitcoin and other cryptocurrencies.

The Whitepaper is divided into four sections:

I. general tax consequences of acquiring, hodling (not a typo!) and disposing of cryptocurrencies;
II. tax considerations relevant to ICOs;
III. tax considerations related to crypto hedge funds and their investors; and
IV. miscellaneous related topics.

*Readers who are not familiar with cryptocurrencies and blockchain technology, which is the backbone of cryptocurrencies, should read Appendix A to the Whitepaper for a not-too-technical overview.

Part I analyzes the limited guidance published by the Internal Revenue Service (IRS) regarding cryptocurrencies. In this guidance, the IRS states that cryptocurrencies that are readily convertible into cash should be treated as property and that general tax principles applicable to property transactions should apply to cryptocurrency transactions. Some crypto investors are surprised to learn that many transactions involving cryptocurrency are taxable, including the purchase of cryptocurrency with a different type of cryptocurrency (e.g., purchasing an “alt-coin” with bitcoin). Hard forks and airdrops are also discussed in this section.

Part II discusses certain tax considerations related to ICOs. ICO issuers contend with an interesting set of tax considerations. For instance, when tokens are issued, are the proceeds from the ICO taxable as income? Could a token pre-sale be structured to defer any income recognition? Is it possible for tokenized equity (or tokenized debt) or other tokens to be treated as equity (or debt) for U.S. federal income tax purposes? If so, the capital raise would not be taxable as income.

Part III discusses certain tax considerations related to hedge funds that invest and trade in cryptocurrencies. Crypto funds deal with many of the same tax issues as other investment funds, but cryptocurrency puts a unique twist on these issues. These issues include structuring considerations, trader or investor determinations, whether open positions can be marked-to-market at the end of each year, and identifying the lot from which a coin or token was sold.

Part IV addresses certain miscellaneous topics. This section answers questions about deductions that may be relevant to crypto investors, the treatment of crypto loans and whether cryptocurrency holdings are subject to information reporting regimes.

The appendix provides an overview of cryptocurrencies and blockchain technology. In particular, the appendix to the Whitepaper analyzes bitcoin, the first cryptocurrency, describing how to trade bitcoin and how the bitcoin ledger is maintained. In addition, the authors describe differences between tokens and coins and explain initial coin offerings (ICOs). Finally, the appendix includes a high-level discussion of classifying cryptocurrencies as securities or commodities, which may not always be dispositive of tax treatment but is relevant to determining the tax treatment of cryptocurrency.

For additional information about the taxation of cryptocurrencies, please contact one of the attorneys listed below or a member of Seward & Kissel’s Blockchain and Cryptocurrency Practice.