US Tax Considerations When Blogging for Magic Internet Money (Part II)

Back in the previous article (https://steemit.com/tax/@lpfaust/us-tax-considerations-when-blogging-for-magic-internet-money-part-i), we covered two basic points when blogging on Steemit:

(i) The IRS views all STEEM and Steem Based Dollar rewards as income, paid in the form of property with a determinable fair market value, which must be reported on your income tax return.
(ii) The method by which we can determine the US Dollar value of the income to be reported.

So now we have determined the income earned for income tax reporting purposes, but we have cryptocurrency (STEEM and Steem Based Dollars) which, ideally we would love to convert into US Dollars at some point. When we convert/sell the STEEM and Steem Based Dollars on the open market, generally we sell at either more than what we valued them at for income reporting purposes (a capital gain) or less than what we valued them at for income reporting (a capital loss). This creates a taxable event which must be reported.

Let’s take a closer look…

But First, The Required Legalese…

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Exchanging Cryptocurrencies for US Dollars (Capital Gains and Capital Losses)

When we exchange the STEEM or Steem Based Dollars for US Dollars, on the open market, we will generally have either a gain or loss on the exchange. How is this calculated?

Capital Gain (or Loss) = US Dollar Sales Price - Basis

What is Basis?

US Code 26 (US Tax Code) defines basis of property as the cost of the property. In general the basis would be the fair market value paid for the property, so if you paid 100 US Dollars for one STEEM token, the basis for the purpose of the capital gain (or loss) calculation for the sale of that STEEM token would be 100 USD.

For purposes of this example, we did not purchase STEEM and Steem Based Dollars, we were paid with them. The basis of the STEEM and Steem Based Dollars earned would be the US Dollar value we calculated for income purposes (see my previous blog on how to do this https://steemit.com/tax/@lpfaust/us-tax-considerations-when-blogging-for-magic-internet-money-part-i).

So, imagine we have 3 Steem Based Dollars we valued for income purposes at 0.80 US Dollars each, and we exchanged them for 0.90 US Dollars each on the exchange, for capital gains tax reporting we would calculate the following:

Capital Gain = US Dollar Sales Price - Basis
Capital Gain = (3 * 0.90 US Dollars) – (3 * 0.80 US Dollars)
Capital Gain = 2.70 US Dollars – 2.40 US Dollars
Capital Gain = 0.30 US Dollars

Pretty Straightforward, huh? But, exchanging STEEM and Steem Based Dollars is not so straightforward. As of the time of this writing, there is no direct conversion from STEEM or Steem Based Dollars to US Dollars. One would have to exchange first to Bitcoin or Ethereum, then to US Dollars. Let’s look at a real world example.

Capital Gains In the Real World

Imagine we have 10 Steem Based Dollars which we valued at 0.80 US Dollars each for income reporting purposes. The current exchange rate of Steem Based Dollars to Bitcoin is 5 Steem Based Dollars for one Bitcoin and Bitcoin is currently worth 200 US Dollars.

First, determine the basis of the Steem Based Dollars in US Dollars (already determined to be 0.80 US Dollars Each).

Next we exchange the Steem Based Dollars for Bitcoin, so the basis of the Bitcoin must be calculated:

Bitcoin Basis = Bitcoin/Steem Based Dollar Exchange Rate * Steem Based Dollar Basis
Bitcoin Basis = (5) * (0.80 US Dollars)
Bitcoin Basis = 4.00 US Dollars

Finally, we determine the capital gain on the exchange

Capital Gain = [(Number of Bitcoins Sold) * (Bitcoin Sale Price)] – [(Number of Bitcoins Sold) * (Bitcoin Basis)]
Capital Gain = (2 * 200.00 US Dollars) – (2 * 4.00 US Dollars)
Capital Gain = 400.00 US Dollars – 8.00 US Dollars
Capital Gain = 392.00 US Dollars

Wrapping Up

Blogging, receiving property as compensation (in the form of STEEM and Steem Based Dollars) and eventually exchanging those cryptocurrencies for US Dollars can, in general, create two taxable events. The first is the taxable income from the determinable fair market value of the STEEM and Steem Based Dollars received. The second taxable event is the capital gain or loss realized on the exchanged when the crypto is converted to US Dollars. Be sure to account for them both.

Hi lpfaust,
A couple of questions regarding "What is Basis?"

Could you explain how cost basis is computed when you have your virtual currency (say, BTC) spread across multiple places, like multiple exchanges? Do you compute cost basis/capital gain in a FIFO manner across all of them (irrespective of where you keep each portion), or separately for each exchange? For instance, consider the following series of purchase and sell transactions:
echange, date, purchase/sell, amt, rate
E1, d1, purchase, 2 BTC, 1 BTC = $1000
E2, d2, purchase, 2 BTC, 1 BTC = $2000
E1, d3, purchase, 2 BTC, 1 BTC = $3000
E2, d4, purchase, 2 BTC, 1 BTC = $4000
E1, d5, sell, 4 BTC, 1 BTC = $5000
We have two options here:
(a) Consider all of our holdings as one big pile irrespective of where they reside, and handle it in a FIFO manner across all of them, so capital gain is: (4 BTC x $5000) - (2 BTC x $1000 + 2 BCT x $2000) = $14000.
(b) Handle each exchange independently, and handle the transactions within that exchange in a FIFO manner, so capital gain is: (4 BTC x $5000) - (2 BTC x $1000 + 2 BCT x $3000) = $12000
Option (a) seems much more natural to me, but I wanted to make sure that's indeed what the law says, if it addresses this aspect at all.
This is a follow-up question in case the answer to my first question is (a). Suppose that a couple files jointly with the IRS. Each has their own virtual currency account in an exchange. Each performs a series of purchase and sell transactions. In order to correctly compute cost basis and consequently capital gain, do we use a FIFO system across the accounts or in each account independently?

Thanks much for your insights!