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BHBM Tax Law Alert 2/27/2018


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FEDERAL TAX LAW UPDATE

Interest on Home Equity Loans May Still be Deductible Under New Tax Bill

In Information Release 2018-32, the IRS clarified that, in many instances, taxpayers can continue to deduct the interest paid on home equity loans under the newly enacted Tax Cuts and Jobs Act of 2017.

Under prior law, taxpayers may deduct interest on mortgage debt that is “acquisition debt.” The new law did not change this. However, the new law temporarily lowers the dollar limit on debt qualifying for the home mortgage interest deduction from $1,000,000 to $750,000.

Further, under prior law, taxpayers could deduct interest on home equity debt that was not “acquisition debt.” The new law temporarily suspends the deduction for interest paid on home equity loans and lines of credit, unless the taxpayer uses the proceeds to buy, build or substantially improve the taxpayer’s residence securing the loan. Similar to prior law, the new law continues to require that the loan be secured by the taxpayer’s principal residence or second home, not exceed the cost of the residence and meet other requirements.

In Information Release 2018-32, the IRS points out that as long as the proceeds of the home equity loan are used to acquire or substantially improve the taxpayer’s home that secures the loan, the interest will be deductible, regardless of how the loan is labeled. Conversely, interest on the same loan used to pay the taxpayer’s personal living expenses, e.g., credit card debts, is not deductible.

For the full text of Information Release 2018-32, please click here.

Taxation of Virtual Currency

On January 31, 2018, Coinbase, the United States’ leading virtual currency exchange issued 1099-K tax forms to specified clients located throughout the country. Specifically, Coinbase issued 1099-K forms for customers who have received cash above the required reporting threshold, which is more than 200 receipt transactions or greater than $20,000 during the year. This development may prompt considerable uncertainty regarding the calculation of taxable income for parties engaged in the trading or mining of virtual currency.

Further, previous failures to timely file and remit taxes on income earned from virtual currency will be taken into account and could result in additional penalties and interest. IRS Notice 2014-21 has provided guidance concerning the taxation of virtual currency, as seen in pertinent part, below.

1: How is virtual currency treated for federal tax purposes?

For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.

2: Must a taxpayer who receives virtual currency as payment for goods or services include in computing gross income the fair market value of the virtual currency?

Yes. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

3: What is the basis of virtual currency received as payment for goods or services in Question 2?

The basis of virtual currency that a taxpayer receives as payment for goods or services in Question 2 is the fair market value of the virtual currency in U.S. dollars as of the date of receipt.

4: How is the fair market value of virtual currency determined?

For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency, which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

5: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

Yes. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

6: What type of gain or loss does a taxpayer realize on the sale or exchange of virtual currency?

The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.

7: Does a taxpayer who “mines” virtual currency (for example, uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger) realize gross income upon receipt of the virtual currency resulting from those activities?

Yes, when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.

8: Is an individual who “mines” virtual currency as a trade or business subject to self-employment tax on the income derived from those activities?

If a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax.

9: Does virtual currency received by an independent contractor for performing services constitute self-employment income?

Yes. Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual other than an employee. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.

10: Will taxpayers be subject to penalties for having treated a virtual currency transaction in a manner that is inconsistent with the tax law?

Taxpayers may be subject to penalties for failure to comply with tax laws. For example, underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In addition, failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under section 6721 and 6722. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish that the underpayment or failure to properly file information returns is due to reasonable cause.


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