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New IRS Requirement: All Taxpayers Must Answer This Question

For federal tax purposes, digital assets are treated as property. General tax principles applicable to property transactions apply to transactions using digital assets. You may be required to report your digital asset activity on your tax return.

Definition of Digital Assets
Digital assets are broadly defined as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.

Digital Assets Include (but are not limited to):

Convertible virtual currency and cryptocurrency
Stablecoins
Non-fungible tokens (NFTs)
Digital assets are not real currency (also known as “fiat”) because they are not the coin and paper money of the United States or a foreign country and are not digitally issued by a government’s central bank.

A digital asset that has an equivalent value in real currency, or acts as a substitute for real currency, has been referred to as convertible virtual currency.

A cryptocurrency is an example of a convertible virtual currency that can be used as payment for goods and services, digitally traded between users, and exchanged for or into real currencies or digital assets.

Tax Consequences
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U.S. Security And Exchange Commission: Crypto Asset Interest-Bearing Accounts

The SEC’s Office of Investor Education and Advocacy and the Division of Enforcement’s Retail Strategy Task Force are issuing this Investor Bulletin to educate investors about risks with accounts that pay interest on crypto asset deposits.

Crypto assets, including so-called cryptocurrencies, stablecoins, tokens, and other digital assets have been of increasing interest to retail investors over the last few years.  This Investor Bulletin highlights the risks that may be involved in a recent financial product related to crypto assets—an interest-bearing account for crypto asset holdings.

Not The Same As Bank Deposits

These products may sound similar to interest-bearing accounts with a bank or credit union, but investors need to be aware that these crypto asset-related accounts are not as safe as bank or credit union deposits.

Banks and credit unions are regulated by both federal and state banking regulators.  Banking rules limit the amount of risk that banks and credit unions are allowed to take with your deposited funds.  These rules are designed to decrease the possibility that your bank or credit union becomes insolvent and unable to provide you your funds when you want to withdraw those funds.

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Cryptocurrency And Asset Protection Trusts

With more investors diversifying their investment portfolios, cryptocurrencies and other kinds of digital assets (i.e., non-fungible tokens “NFTs”) have become a more popular option in recent years. With the Internal Revenue Service declaring that digital assets are property, they can be accessed by creditors, however, so certain kinds of trusts may be established to help protect these assets as well as enabling access to online accounts, especially for cryptocurrency assets. A state-based Domestic Asset Protection Trust (DAPT) enables a trust creator (“trustor”) to protect their exiting digital assets through a legal instrument that shields them from creditors. Previously, these types of trusts were only available offshore. Fortunately, many states across the U.S. have adopted DAPT statutes to allow this type of trust to be legally-established within their jurisdictions.

What is a Domestic Asset Protection Trust?

Before DAPTs were enacted, a trustor/settlor would have to establish an irrevocable trust created by a third party in order for asset protection. A DAPT is a self-settled trust that allows the trustor/settlor protection to be the beneficiary, transfer a portion of estate assets to the trust, and provide for certain protections from future creditors, legal complaints, malpractice claims, and other financially-consequential events. Formally known as a qualified spendthrift trust, it is a trust that enables the trustor to transfer assets into a trust of which the trustor/settlor is also a beneficiary to protect themselves from creditors. This type of irrevocable trust may assure that wealth can be safeguarded for future generations and protects wealth from liability risk.

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Asset Protection Trusts For Cryptocurrency and Digital Assets

Asset Protection Trusts for Cryptocurrency and Digital Assets

With more investors diversifying their investment portfolios, cryptocurrencies and other kinds of digital assets (i.e., non-fungible tokens “NFTs”) have become a more popular option in recent years. With the Internal Revenue Service declaring that digital assets are property, they can be accessed by creditors, however, so certain kinds of trusts may be established to help protect these assets as well as enabling access to online accounts, especially for cryptocurrency assets. A state-based Domestic Asset Protection Trust (DAPT) enables a trust creator (“trustor”) to protect their exiting digital assets through a legal instrument that shields them from creditors. Previously, these types of trusts were only available offshore. Fortunately, many states across the U.S. have adopted DAPT statutes to allow this type of trust to be legally-established within their jurisdictions.

What is a Domestic Asset Protection Trust?

Before DAPTs were enacted, a trustor/settlor would have to establish an irrevocable trust created by a third party in order for asset protection. A DAPT is a self-settled trust that allows the trustor/settlor protection to be the beneficiary, transfer a portion of estate assets to the trust, and provide for certain protections from future creditors, legal complaints, malpractice claims, and other financially-consequential events. Formally known as a qualified spendthrift trust, it is a trust that enables the trustor to transfer assets into a trust of which the trustor/settlor is also a beneficiary to protect themselves from creditors. This type of irrevocable trust may assure that wealth can be safeguarded for future generations and protects wealth from liability risk.

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IRS Confirms Pre 2018 Crypto Exchanges Do Not Qualify For Section 1031 Exchange Treatment

New IRS guidance has confirmed that pre-2018 exchanges of Bitcoin, Ether and Litecoin do not qualify for Section 1031 exchange treatment.  Prior to 2018, taxpayers were permitted to defer capital gains taxes under Section 1031 for certain exchanges of personal property (1031 is now limited only to exchanges of real property).  The IRS’s rationale is that these were not exchanges of like-kind property and so were taxable even prior to tax reform. The IRS found that Bitcoin and Ether each had special roles in cryptocurrency trading because if taxpayers wanted to trade in other types of virtual currency, they had to first exchange the other currency into or from Bitcoin or Ether.  Therefore, exchanges between Litecoin and Bitcoin/Ether did not qualify as “like kind”.

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Cryptocurrencies: How They Work

The virtual currencies that have gotten the most attention are cryptocurrencies, which are used to transact business directly between two parties without going through a banking system.

Using a cryptocurrency is very different from paying with traditional currency. It’s a process with its own unique digital features, a distinctive underlying technology, and a highly specialized vocabulary.

To understand how cryptocurrency works, let’s look at a situation where it may be used.

Let’s assume you are selling a mountain bike to your cousin, using Bitcoin for the transaction. Each of you would each have a digital wallet that contains your private key—an alpha-numeric code of at least 16 characters (punctuation marks are encouraged!) that is far more comprehensive than a PIN. The private key, which should be kept entirely secure, enables you spend the Bitcoins allocated to your account.

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Digital Asset Reporting

On August 10, 2021, the U.S. Senate passed a $1 trillion infrastructure bill after months of negotiations. Tucked away within the sweeping legislation are measures that would extend Form 1099-B and cost basis reporting requirements to so-called “digital assets” such as Bitcoin and Ethereum. The requirements, which are expected to raise $28 million of revenue for the bill, could impose onerous tax reporting obligations on crypto miners, software developers, and other players in the industry that may not have the resources or capabilities to report user transactions.

The Proposed Reporting Requirements

Under the Senate bill, starting on January 1, 2023, a “broker” will be required to report transactions involving “digital assets” for the calendar year to the IRS on Forms 1099-B or another similar tax form. The legislation would treat digital assets as “specified securities,” meaning brokers would need to track and report such information as the identity of customers as well as the cost basis and gain/loss from the sale of digital assets. Under the bill, brokers would also be required to report transfers of digital assets to non-brokers. For purposes of the new requirement, digital assets would include any “digital representation of value” recorded on a blockchain or similar technology. This expansive definition would cover all cryptocurrencies and potentially other forms of digital assets such as non-fungible tokens (NFTs). As with traditional Form 1099-B reporting, taxpayers may be subject to substantial penalties for failure to file or timely file an informational return with the IRS.

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Crypto And §1031 - Still Relevant In California!
In 2019, California only partially conformed to the section 1031 changes made by the Tax Cuts and Jobs Act. For individuals below specified AGI levels in the year an exchange begins, the pre-TCJA version applies. These levels are under $500,000 of AGI for MFJ and HH and under $250,000 for single.
Besides real property, what might individuals exchange? Well today, the most common non-real property exchanged by the roughly 95% of Californians who are still subject to section 1031 is cryptocurrency! Many types of virtual currency can only be acquired with bitcoin or another virtual currency.
Of course, few people are dealing with virtual currency, but the number grows each day.
What are the factors that should be considered to know if one virtual currency held for investment or business is like-kind to another?

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New Tax Reporting Requirements For Cryptocurrencies And Other Digital Assets In Senate Infrastructure Bill

On August 10, 2021, the U.S. Senate passed a $1 trillion infrastructure bill after months of negotiations. Tucked away within the sweeping legislation are measures that would extend Form 1099-B and cost basis reporting requirements to so-called “digital assets” such as Bitcoin and Ethereum. The requirements, which are expected to raise $28 million of revenue for the bill, could impose onerous tax reporting obligations on crypto miners, software developers, and other players in the industry that may not have the resources or capabilities to report user transactions.

The Proposed Reporting Requirements

Under the Senate bill, starting on January 1, 2023, a “broker” will be required to report transactions involving “digital assets” for the calendar year to the IRS on Forms 1099-B or another similar tax form. The legislation would treat digital assets as “specified securities,” meaning brokers would need to track and report such information as the identity of customers as well as the cost basis and gain/loss from the sale of digital assets. Under the bill, brokers would also be required to report transfers of digital assets to non-brokers. For purposes of the new requirement, digital assets would include any “digital representation of value” recorded on a blockchain or similar technology. This expansive definition would cover all cryptocurrencies and potentially other forms of digital assets such as non-fungible tokens (NFTs). As with traditional Form 1099-B reporting, taxpayers may be subject to substantial penalties for failure to file or timely file an informational return with the IRS.

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Cryptocurrency, Third-Party Subpoenas, And Personal Jurisdiction Collide - Strobel v. Lesnick

Coinbase, Mt. Gox, and Gemini are well-known virtual currency exchanges. It is through these exchanges that cryptocurrency users may execute transactions (e.g., a Bitcoin transfer—whereby a transaction announcement occurs on the blockchain). As noted in a previous blog post, cryptocurrency transactions are pseudonymous, not anonymous. Further, cryptocurrency users do not have Fourth Amendment privacy interests in their virtual currency transaction records. See Bare Bitcoins – No Fourth Amendment Privacy in Virtual Currency Records. However, in the civil context, are litigants privy to blockchain information to identify users? Last Friday, a federal district court dealt with whether a civil litigant could apply for leave to serve a third-party subpoena on certain cryptocurrency exchange platforms.

Strobel v. Lesnick, et al.

A. Background

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Court Authorizes Service Of John Doe Summons Seeking Identities Of U.S. Taxpayers Who Have Used Cryptocurrency

A federal court in the Northern District of California entered an order today authorizing the IRS to serve a John Doe summons on Payward Ventures Inc., and Subsidiaries d/b/a Kraken (Kraken) seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is seeking the records of Americans who engaged in business with or through Kraken, a digital currency exchanger headquartered in San Francisco, California.

“Gathering the information in the summons approved today is an important step to ensure cryptocurrency owners are following the tax laws,” said Acting Assistant Attorney General David A. Hubbert of the Justice Department’s Tax Division. “Those who transact with cryptocurrency must meet their tax obligations like any other taxpayer.”

“There is no excuse for taxpayers continuing to fail to report the income earned and taxes due from virtual currency transactions,” said IRS Commissioner Chuck Rettig. “This John Doe summons is part of our effort to uncover those who are trying to skirt reporting and avoid paying their fair share.”

Cryptocurrency, as generally defined, is a digital representation of value. Because transactions in cryptocurrencies can be difficult to trace and have an inherently pseudoanonymous aspect, taxpayers may be using them to hide taxable income from the IRS. On April 1, 2021, a federal court in the District of Massachusetts granted an order authorizing the IRS to serve a similar John Doe summons on Circle, a digital currency exchange headquartered in Boston.

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The United States’ Need To Reevaluate Legislation On International Cybercrime To Successfully Compel Forfeiture of Digital Assets Abroad

Four United States government agencies collaborated in an investigation of North Korean hackers who targeted and stole over $250 million worth of various cryptocurrencies from two South Korean cryptocurrency exchanges in July 2019 and March 2020.[1] A civil in rem forfeiture complaint filed on behalf of the United States on August 27th, 2020 seeks the forfeiture of 280 virtual currency accounts belonging to the hackers. Although the techniques used by the agencies to trace the stolen funds is impressive, the task of seizing the assets still remains and presents a unique problem.

The issue for seizing the cryptocurrency wallets involves two elements. First, seizing cryptocurrency abroad requires multiple legal hurdles to clear. Second, the property belongs to a country with tense political relations to the United States. The government is faced with the issue of enforcing a forfeiture against an almost untouchable entity.

The Attack & Investigation

The American agencies utilized a U.N. report by the U.N.’s Security Council to suspect North Korean hackers as masterminds of the attack.[2] North Korean hackers previously attacked South Korean crypto exchanges to fund their regime’s weapons development program.[3] With this information, the agencies used advanced tracing techniques to obtain and track the hacker’s transactions, wallet addresses, clusters on the blockchain, email and exchange accounts, and VPN addresses to confirm North Korean hackers were indeed behind the attack.

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