ZGL wallet: achieve zero gain/loss for tax purposes with coin control

[Peter R]

The recent IRS guidance changes no laws regarding the tax treatment of bitcoin; however, it gives clarity to individuals and businesses.  I believe this clarity is necessary in order to push forward adoption.

Reading user comments, I get the sense that some people are concerned about gain/loss accounting paperwork for day-to-day purchases should they choose to report to the IRS.  Barry Silbert mentioned that automated wallet software is ready and the owner of https://bitcointaxes.info has been promoting his website on the forum.  So we already have this and more will soon come.

But Holliday just said something that blew my mind:

…FIFO…LIFO...debate about how to pick which coin to spend for taxes purpose…LIFO…FIFO…

Of course you can pick if you are using a wallet with coin control.

Because of this property of bitcoin, it is possible to design a wallet that automatically organizes your day-to-day spending such that the capital gain is identically zero for each and every purchase that you make:  

If you have a sufficient amount of coins acquired both above and below the current bitcoin price, then it is always possible to create a new coin that is a linear combination of your existing coins that has a gain/loss for tax purposes of identically zero.

Assume the current price of bitcoin is $600, and assume that you control Coin Set A acquired at $200 (gain of $400) and Coin Set B acquired at $1200 (loss of $600).  If you wish to purchase a coffee for $2 and not deal with gain/loss accounting, your wallet can automatically select a suitable combination from the two sets of coins such that the present value is $2 (to pay for the coffee) and the gain/loss is identically zero (to simplify your taxes).  

In[1120]:= Solve[{400 a - 600 b == 0, 600. (a + b) == 2}, {a, b}]

Out[1120]= {{a -> 0.002, b -> 0.00133333}}

Provided your wallet has real-time BTC price data from a reliable source, and provided your wallet has knowledge of your cost basis, it would know to purchase your coffee using 2.0 mBTC from Coin Set A and 1.33333 mBTC from Coin Set B.  In other words it would forge a ZGL (zero gain/loss) coin specially for this purchase.  

ZGL coins are created in real time (they are "current") such that at the moment of creation (spending) your gain/loss is identically zero.  

The ZGL wallet does not allow you to avoid incurring capital gains.  Instead, it allows you to defer realizing capital gains over a long sequence of day-to-day transactions, effectively lumping the gain/loss in a much smaller number of events where a gain or loss was realized (coin swaps).  This reduces paperwork for both the filer and the IRS, and helps to preserve the privacy of your day-to-day transactions.  Its simplicity makes it easier to comply with US tax law, increasing expected revenue for the IRS.  

The way these "lump sum" capital gains work is as follows: eventually, if the bitcoin price continues to rise, your wallet will run out of "high cost basis" coins and will no longer be able of forge ZGL coins.  I think the most effective way to realize a capital gain for tax purposes is to use a coin swap service (also known as a mixer).  Your wallet would send 1 BTC + fee into the mixer and receive a new 1 BTC coin sharing 0 taint with the original coin.  Since this is a new piece of property exchanged at arm's length, you are required to recognize the capital gain on this "low cost basis" coin you just swapped.  Your ZGL wallet would automatically initiate these swaps when required, logging all pertinent tax data to ensure compliance with US tax laws.  When filing your taxes, you would report each of these swap events where you realized a capital gain or loss.  For example, you may report 12 such events if the price over the year was rapidly increasing, and perhaps 0 such events in a declining market.  

From my preliminary research, it seems the ZGL concept is on solid legal grounds.  However, there is one unresolved question: is there a requirement to report the ZGL transactions that did not result in a capital gain, or is it sufficient to report only the transactions where a gain was realized but keep private records such that you could prove your claims if audited?  I have posted a poll question to get us thinking about this.  

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[seriouscoin]

I probably dont remember correctly,

but by Coin Set X, you mean tx X and not Wallet or Address X right?

[smooth]

The idea is that if you have some coins purchased below the current price and some coins purchased above the current price, then it is always possible to create a new coin that is a linear combination of your existing coins that has a gain/loss for tax purposes of identically zero.

Good idea.

Small correction to how you stated it though. You have to have not just "some" coins purchased below and above, but a sufficient number. which depends on the relationship between the current price and the prices at which they were purchased. Which is to say your little solver needs constraints on a and b.

A simple example would be if you have coins at purchased at 1 and coins purchased at 100 when the current price is 2. You need a lot more of the 1 coins to make this work. I don't think you can realize losses by just doing a quick round-trip trade either, due to the wash sale rules, though I think you can realize gains that way.

But in many (less contrived) instances this should work and should greatly reduce the number taxable events, especially on small transactions like buying a cup of coffee.

[Peter R]

Small correction to how you stated it though. You have to have not just "some" coins purchased below and above, but a sufficient number. which depends on the relationship between the current price and the prices at which they were purchased. Which is to say your little solver needs constraints on a and b.

Thanks for helping to improve the accuracy of that statement Smooth.  I have updated the OP to reflect (it is important to be precise with our logic).

As a note to readers, the ZGL-wallet (zero-gain/loss wallet) does not allow you to permanently avoid paying capital gains taxes.  Instead, it allows you to defer realizing capital gains over a long sequence of day-to-day transactions, effectively lumping the gain/loss in a much smaller number of events where a gain or loss was realized (bitcoin/dollar trades).  

ZGL-coins are created in real time (they are "current") such that at the moment of creation (spending) your gain/loss is identically zero.  In other words, ZGL-coins are currency.  

Note also that this wallet would be difficult to use when bitcoin is consistently making all-time highs (e.g., such as November 2013).

[RodeoX]

This is an interesting idea. I use the "first out" accounting method for calculating my tax. It may be possible to better my tax situation using something like this. I could spend certain coins to control my income from capitol gains in a given year. At least I think that's right.

[Peter R]

Let's assume a ZGL wallet exists and is functional.

Will these wash transactions need to be reported to the IRS? Obviously, it makes no sense to report them, but I've never known bureaucracy to make much sense. I'm assuming they will want to actually see the capital gains offset the capital losses, but I don't like assuming things.

My thinking is that spending ZGL coins would not be subject to any reporting requirements, although I'd like to hear DeathAndTaxes or BCB's opinion on this matter.  There is provably zero gain/loss on each transaction.  If you have a capital loss (or zero gain) on a normal transaction, at least here in Canada, you aren't required to report it.  

If you were audited, then you'd have a paper trail that proves the transactions were all zero gain/loss and that you were correct in reporting nothing.  

To readers: I am not a lawyer, accountant or tax specialist.  

[jbreher]

Thanks for expanding your thought. I didn't catch the implication when you stated that Holliday's post 'blew your mind' in that there other thread.

This is a really cool idea. I hope a SW team picks it up and runs with it.

[hello_good_sir]

More useful would be to something that attempts to maximize the capital gains that you report, up to a threshold.

In the US you pay 0% on long-term capital gains until your income gets to something like $72,000 for married people, and then the rate jumps to 20%.  Let's say that you make $50,000 per year.  I would want the software to ensure that I use coins such that I come out with exactly $22,000 in capital gains.  That way I pay no capital gains taxes this year and it also reduces my future tax liability.

[Peter R]

In this article, Georgetown Law professor Adam J. Levitin states that since bitcoin outputs are unique, each output could be subject to a different tax liability depending on its cost basis.  He argues that this decreases fungibility, but I argue that this gives validity to the concept of ZGL coins.  ZGL coins are dynamically fused by wallets with ZGL support to be "current" so that using them results in a capital gain/loss of identically zero.

http://www.theatlantic.com/technology/archive/2014/03/why-bitcoin-can-no-longer-work-as-a-virtual-currency-in-1-paragraph/359648/

[jbreher]

In this article, Georgetown Law professor Adam J. Levitin states that since bitcoin outputs are unique, each output could be subject to a different tax liability depending on its cost basis.  He argues that this decreases fungibility,

I think Levitin's argument is false. In my mind, the fungibility property of money is only relevant in exchange between parties. I think it only matters to the receiving party. To the receiving party, it is immaterial how long the giving party has owned it, nor how much capital gain the giver needs to pay.

While I have no specific education in the matter, it would seem to me that money's fungibility property is useful only in that it trivializes the receiver's assessment of the money's quality aspects. If a received bitcoin is indistinguishable from any other received bitcoin, the receiver need only think about overall quantity rather than quality of each bitcoin.

The giver needs to evaluate the quality of each bitcoin, but that determination is not coupled in time to the transaction. Indeed, this decision process is something that could plausibly be automated according a policy decision by the giving party - perhaps via some mechanism such as the ZGL wallet.

[acoindr]

I don't think this would work. This tax attorney advises using the FIFO method and nothing else for bitcoins.

The biggest issue for most bitcoin users is determining their basis. Because bitcoins are fungible, you run into the problem of tracing the cost of each bitcoin you hold. You cannot just arbitrarily choose your basis. The IRS will permit you to use the FIFO method (First in, First out). Any other method such as LIFO or Average Cost Basis is not advisable, particularly now that we know foreign currency rules do not apply

[smooth]

I don't think this would work. This tax attorney advises using the FIFO method and nothing else for bitcoins.

I don't follow his reasoning.

Because bitcoins are fungible, you run into the problem of tracing the cost of each bitcoin you hold.

Yet stock shares are fungible and the specific lot method is definitely allowed for stock shares.

[Peter R]

I don't think this would work. This tax attorney advises using the FIFO method and nothing else for bitcoins.

Levitin said that fact that each bitcoin was unique with a different cost basis would have complex (read: useful) tax accounting repercussions:

https://bitcointalk.org/index.php?topic=531135.msg5919137#msg5919137

I am hoping DeathAndTaxes and BCB provide comments, but my understanding now is that LIFO and FIFO are legal techniques used to simplify tax accounting.  You always have the option to pay taxes on the actual gain for each piece of property that you sell or trade.

What I am less certain of is this: what are your legal obligations if you exchange property in a single transaction without realizing a capital gain?

[acoindr]

I am hoping DeathAndTaxes and BCB provide comments, but my understanding now is that LIFO and FIFO are legal techniques used to simplify tax accounting.  You always have the option to pay taxes on the actual gain for each piece of property that you sell or trade.

VERY good point! True, there is always the option to be as anal with accounting as you like for tax purposes, and that's generally preferable.

What I am less certain of is this: what are your legal obligations if you exchange property in a single transaction without realizing a capital gain?

Good question, but I'd imagine as long as you could meticulously show there was no gain, then that's just what it is.

[BitEscrow]

 Changes nothing? Keep believing what you want to believe you retards. It means you can no longer run around; prancing like idiots saying you own everything.

[The_Gloomfrost]

I like the part which incentivizes buying coins when the price is relatively high. Your downside is essentially covered by future tax breaks. Nice!

[seriouscoin]

OP, how do you handles change  tx?

How do you convince the IRS that certain tx are just "changes" hence those tx outputs are still considered long term.

[seriouscoin]

OP, how do you handles change  tx?

How do you convince the IRS that certain tx are just "changes" hence those tx outputs are still considered long term.

I make a transaction from A to B with change going to C.

I control the private keys for A. I control the private keys for C.

How much more proof do you need?

what if C is also an address that you already have, "not new address"
Also how do you handle refund?

The address is being reused which makes it harder to audit.

Bottom line is, can this new wallet client manage at tx level and throw out addresses completely?

[DannyHamilton]

OP, how do you handles change  tx?

How do you convince the IRS that certain tx are just "changes" hence those tx outputs are still considered long term.

I make a transaction from A to B with change going to C.

I control the private keys for A. I control the private keys for C.

How much more proof do you need?

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

[seriouscoin]

Also would the IRS have to do analysis of the whole blockchain to properly identify the validity of certain tax payers?

Say in the change example, if C is a new address which IRS would not know until C is "spent"

In order to claim it as a long term gain, Holiday will say C is just change from previous tx between A and B.

IRS has to then analyze if what he said is true by checking C's previous tx....

[seriouscoin]

OP, how do you handles change  tx?

How do you convince the IRS that certain tx are just "changes" hence those tx outputs are still considered long term.

I make a transaction from A to B with change going to C.

I control the private keys for A. I control the private keys for C.

How much more proof do you need?

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

Ask someone who can code Bitcoin transactions / do math!

Obviously there will be limitations as to what a "wash client" will be able to accomplish, but I see no reason people shouldn't try to use one if they are trying to abide by their local tax laws and reduce their tax burden at the same time.

Also note, btc is divisible up to 8 decimals..... its not like how you treat stocks.

[seriouscoin]

Also would the IRS have to do analysis of the whole blockchain to properly identify the validity of certain tax payers?

Say in the change example, if C is a new address which IRS would not know until C is "spent"

In order to claim it as a long term gain, Holiday will say C is just change from previous tx between A and B.

IRS has to then analyze if what he said is true by checking C's previous tx....

Well the IRS got themselves into this mess. I'm sure they can simply hire more bureaucrats at the expense of the taxpayers to solve these problem.

Or some financial institute will lobby to be a bitcoin "bank" where you can spend your btc from your acct and thus IRS will trust the account records of the bitcoin "bank"

[seriouscoin]

OP, how do you handles change  tx?

How do you convince the IRS that certain tx are just "changes" hence those tx outputs are still considered long term.

I make a transaction from A to B with change going to C.

I control the private keys for A. I control the private keys for C.

How much more proof do you need?

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

Ask someone who can code Bitcoin transactions / do math!

Obviously there will be limitations as to what a "wash client" will be able to accomplish, but I see no reason people shouldn't try to use one if they are trying to abide by their local tax laws and reduce their tax burden at the same time.

Also note, btc is divisible up to 8 decimals..... its not like how you treat stocks.

Which should give it added flexibility.

IRS: " you're telling me you just bought a Lambo without having to pay any capital gain tax? "

Holiday: " yes sir, here is my record to prove it"   * hanging the IRS 40,000 pages of tx records *

You think they would not just slap you with a penalty and fine, and let you spend your time and money thro court process?

[smooth]

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

You can't reset your basis (or holding period) by trading with yourself, so any change outputs would retain their original basis. Moving your own asset around, for example moving a stock between certificate form and book entry form, does not change your basis.

The outputs that represent spending would have a new basis (to the recipient), and would be a sale by you.

Of course, I am not the IRS. They might see it differently.

[smooth]

IRS: " you're telling me you just bought a Lambo without having to pay any capital gain tax? "

Holiday: " yes sir, here is my record to prove it"   * hanging the IRS 40,000 pages of tx records *

You think they would not just slap you with a penalty and fine, and let you spend your time and money thro court process?

It doesn't work that way. If you made the money by holding btc, you will have capital gains, maybe not on that transaction, but on some other transaction. Reread the OP. It explains that this does not eliminate capital gains, it just groups them into a smaller number of larger transactions instead of throwing off a tiny bit of gain every time you buy coffee.

If you made the money some other way, you would have documentation for that income and the IRS doesn't care that you are buying a Lambo.

The only case where the IRS cares that you are buying a Lambo is when you don't have the documented income to justify buying one. The ZGL wallet has nothing to do with that at all.

[DannyHamilton]

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

You can't reset your basis (or holding period) by trading with yourself, so any change outputs would retain their original basis. Moving your own asset around, for example moving a stock between certificate form and book entry form, does not change your basis.

The outputs that represent spending would have a new basis (to the recipient), and would be a sale by you.

Of course, I am not the IRS. They might see it differently.

But the problem is I have 2 inputs each with vastly different basis, and only one output.  How do I determine how much of the first input was spent and how much of the second input was spent?  Clearly the new output will have to have a new basis that is somehow a combination of the two original inputs.

I suppose it would be treated a bit like if I sold two previous separate stock purchases and then immediately made a new single purchase of the stock at the current price?

[Peter R]

@ Seriouscoin: there are many ways you could handle the details.  The important part is that with sufficient coins purchased above and below the current market price, it is always possible to pick a suitable linear combination that would result in a ZGL coin.  

In a very simple case, the wallet would have two addresses: Address A where it stores coins purchased at (say) $200, and Address B where it stores coins purchased at (say) $1000.  The ZGL transaction would have at least 2 inputs (coins from A and B) and probably 3 outputs (coins to the merchant, and change back to A and B).  If you really want to be anal about taint, then you'd need to use two intermediary addresses, but this is provably redundant with a proper ZGL set-up so likely not required.  

In a more complex case, Addresses A and B could each be BIP32 deterministic address chains to improve privacy.  

Of course, you can have C, D, E, … as well.  All that matters is that your ZGL wallet knows the cost basis of any coins entering the ZGL section and the current market price: with this information it can create a ZGL coin.  By default, the wallet would probably assume that the cost basis of coins entering do so at the current market price unless you specified otherwise.  

Another thing I realized, is that you don't have to convert to USD to recognize a gain to "recharge" your high-cost basis coins.  Just like you aren't allowed to play tricks to force a capital loss, you aren't allowed to play tricks to avoid recognizing a capital gain.  This means that an automated swap with an arm's length 3rd party of your "low cost basis" bitcoins, into litecoins, and back into bitcoins, would be a "taxable event," giving you a new batch of "high cost basis" coins that the ZGL wallet could use.  

Of course, this ZGL wallet doesn't solve every hassle.  For instance, if the bitcoin price keeps making all time highs, you'd likely keep running out of "high cost basis coins" and be forced to recognize a greater number of "taxable events."


The existence of ZGL coins means that it is possible that a user could make daily bitcoin purchases without ever recognizing a capital gain or loss.  

[seriouscoin]

IRS: " you're telling me you just bought a Lambo without having to pay any capital gain tax? "

Holiday: " yes sir, here is my record to prove it"   * hanging the IRS 40,000 pages of tx records *

You think they would not just slap you with a penalty and fine, and let you spend your time and money thro court process?

It doesn't work that way. If you made the money by holding btc, you will have capital gains, maybe not on that transaction, but on some other transaction. Reread the OP. It explains that this does not eliminate capital gains, it just groups them into a smaller number of larger transactions instead of throwing off a tiny bit of gain every time you buy coffee.

If you made the money some other way, you would have documentation for that income and the IRS doesn't care that you are buying a Lambo.

The only case where the IRS cares that you are buying a Lambo is when you don't have the documented income to justify buying one. The ZGL wallet has nothing to do with that at all.

You misunderstood my example completely.

The IRS WILL audit when you claim you dont have any capital gain. I'm fully aware that the wallet client doesnt not eliminate tax, but helping you to avoid paying tx thro book keeping.

[bananas]

You don't need a wallet for this.

You just tell IRS, i bought 1 btc for 500 and 1 for 1000.
Sold 1 for 800, but it was the 1000 one.

[Peter R]

The IRS WILL audit when you claim you dont have any capital gain.

If there is no capital gain, is there anything to claim?

[Peter R]

You don't need a wallet for this.

You just tell IRS, i bought 1 btc for 500 and 1 for 1000.
Sold 1 for 800, but it was the 1000 one.

That's a good point bananas.  If you spend your high-cost-basis coin, then you'd have a capital loss, and, at least in Canada, would not be subject to any reporting requirements.    

The ZGL concept makes this process more tax efficient (you have exactly zero gain/loss) and keeps better records in case you ever did want to prove it.  

[smooth]

IRS: " you're telling me you just bought a Lambo without having to pay any capital gain tax? "

Holiday: " yes sir, here is my record to prove it"   * hanging the IRS 40,000 pages of tx records *

You think they would not just slap you with a penalty and fine, and let you spend your time and money thro court process?

It doesn't work that way. If you made the money by holding btc, you will have capital gains, maybe not on that transaction, but on some other transaction. Reread the OP. It explains that this does not eliminate capital gains, it just groups them into a smaller number of larger transactions instead of throwing off a tiny bit of gain every time you buy coffee.

If you made the money some other way, you would have documentation for that income and the IRS doesn't care that you are buying a Lambo.

The only case where the IRS cares that you are buying a Lambo is when you don't have the documented income to justify buying one. The ZGL wallet has nothing to do with that at all.

You misunderstood my example completely.

The IRS WILL audit when you claim you dont have any capital gain. I'm fully aware that the wallet client doesnt not eliminate tax, but helping you to avoid paying tx thro book keeping.

You still don't understand. If you made $200K from bitcoin, you WILL have a capital gain, which you should report, and if you report a 200K capital gain and buy a Lambo, you should not have an issue with the IRS.

The only way ZGL avoids having a capital gain is if you BOUGHT a sufficient number of coins ABOVE the price at which you are selling them. If you did that, then you very likely have USD income you are supposed to be reporting.

Nothing you can do will prevent you from being audited. If you report a $200K capital gain, they may still audit you, in fact the more income you report the more likely you are to get audited, all else being equal.

[seriouscoin]

IRS: " you're telling me you just bought a Lambo without having to pay any capital gain tax? "

Holiday: " yes sir, here is my record to prove it"   * hanging the IRS 40,000 pages of tx records *

You think they would not just slap you with a penalty and fine, and let you spend your time and money thro court process?

It doesn't work that way. If you made the money by holding btc, you will have capital gains, maybe not on that transaction, but on some other transaction. Reread the OP. It explains that this does not eliminate capital gains, it just groups them into a smaller number of larger transactions instead of throwing off a tiny bit of gain every time you buy coffee.

If you made the money some other way, you would have documentation for that income and the IRS doesn't care that you are buying a Lambo.

The only case where the IRS cares that you are buying a Lambo is when you don't have the documented income to justify buying one. The ZGL wallet has nothing to do with that at all.

You misunderstood my example completely.

The IRS WILL audit when you claim you dont have any capital gain. I'm fully aware that the wallet client doesnt not eliminate tax, but helping you to avoid paying tx thro book keeping.

You still don't understand. If you made $200K from bitcoin, you WILL have a capital gain, which you should report, and if you report a 200K capital gain and buy a Lambo, you should not have an issue with the IRS.

The only way ZGL avoids having a capital gain is if you BOUGHT a sufficient number of coins ABOVE the price at which you are selling them. If you did that, then you very likely have USD income you are supposed to be reporting.

Nothing you can do will prevent you from being audited. If you report a $200K capital gain, they may still audit you, in fact the more income you report the more likely you are to get audited, all else being equal.

Gee didnt i already say ZGL is just book keeping? Why do you still insist i meant he gained $200k?

I'm not saying you MAKE $200k. But simply you purchase $200k asset. You will be asked questions and audited.

At least with traditional banking system, it will be very clear if the money you used was taxed or not. Now with bitcoin you will have issue if you cant prove thats your money or not and if there is capital gain or not.

[Peter R]

Gee didnt i already say ZGL is just book keeping? Why do you still insist i meant he gained $200k?

I'm not saying you MAKE $200k. But simply you purchase $200k asset. You will be asked questions and audited.

At least with traditional banking system, it will be very clear if the money you used was taxed or not. Now with bitcoin you will have issue if you cant prove thats your money or not and if there is capital gain or not.

If you purchase a $200k asset with bitcoins, then unless you paid more than $200k for those bitcoins, you've realized a capital gain and should declare it.  If you sell some stock and buy a $200k asset, then unless you paid more than $200k for those stocks, you've realized a capital gain and should declare it.

If this $200k asset is a yellow Lamborghini, then the dealership is required to file a report for AML purposes.  But they would file this report whether you paid using BitPay or with a bank wire. And what makes you think that buying an asset would lead to being "asked questions and audited" in the first place?

This has nothing to do with ZGL and very little to do with bitcoin. 

[seriouscoin]

Gee didnt i already say ZGL is just book keeping? Why do you still insist i meant he gained $200k?

I'm not saying you MAKE $200k. But simply you purchase $200k asset. You will be asked questions and audited.

At least with traditional banking system, it will be very clear if the money you used was taxed or not. Now with bitcoin you will have issue if you cant prove thats your money or not and if there is capital gain or not.

If you purchase a $200k asset with bitcoins, then unless you paid more than $200k for those bitcoins, you've realized a capital gain and should declare it.  If you sell some stock and buy a $200k asset, then unless you paid more than $200k for those stocks, you've realized a capital gain and should declare it.

If this $200k asset is a yellow Lamborghini, then the dealership is required to file a report for AML purposes.  But they would file this report whether you paid using BitPay or with a bank wire. And what makes you think that buying an asset would lead to being "asked questions and audited" in the first place?

This has nothing to do with ZGL and very little to do with bitcoin.  

My point is with traditional banking, there is very little work the IRS has to do. But with bitcoins, they're not happy if you hand them 40,000 pages of tx records.

I never said you gained income. But in the eyes of IRS, they dont have info from your banks to verify.

This goes back to my bitcoin "bank" theory. And gods know what coin validity leads us.

Also i would argue ZGL only use avg cost basis of address, it certainly helps but doesnt cover all scenarios.

[Bit_Happy]

I find all this very interesting. These are the kinds of things that set Bitcoin apart from traditional assets and just gives me a good feeling about the future.

The zero-gain/loss wallet is amazing.
Even better, could a secure wallet like Armory add this feature?

[smooth]

My point is with traditional banking, there is very little work the IRS has to do. But with bitcoins, they're not happy if you hand them 40,000 pages of tx records.

With a bank there is very little to do. With stocks (or commodities, etc.) trades, there are many transaction records. In fact the IRS doesn't really get involved, the sales are reported but it is up to you to come up with documentation for the cost basis and holding period. If they have some reason to doubt your accounting (i.e. someone who claims to lose money all the time yet is buying houses and cars) it may be challenged, and the records will need to be examined. Otherwise they never look at it. Most of the tax system in the US is based on voluntary compliance.

[Peter R]

The zero-gain/loss wallet is amazing.
Even better, could a secure wallet like Armory add this feature?

I'm glad you like the idea.

I don't see why ZGL support couldn't be added as a feature for Armory, or any other wallet for that matter.  It requires detailed coin control, but from the user perspective the complexity can remain entirely hidden.  

The wallet would need to have real-time BTC price data from a source that the IRS would deem reliable, and it would need a way to occasionally realize capital gains on "low cost basis" coins.  

I think the most effective way to realize a capital gain for tax purposes is to use a coin mixer.  You would send 1 BTC + fee into the mixer and receive a new 1 BTC coin sharing 0 taint with the original coin.  Since this is a new piece of property exchanged at arm's length, you are required to recognize the capital gain on this "low cost basis" coin you sent into the mixer at the moment of the exchange.  

This has the added benefit that it legitimizes the use of coin mixers (which some erroneously view as being only useful for illicit purposes).  By using coin mixers in the ZGL wallet, we can more accurately ensure compliance with US tax laws.

[counter]

yea I think it moved after I got done with the first post.... 
Seriously this is some clever thinking on the part of the Op and I for one plan to look into this as things progress which I suspect will be rather quickly for the most part +5..

[mysidia]

You don't need a wallet for this.
You just tell IRS, i bought 1 btc for 500 and 1 for 1000.
Sold 1 for 800, but it was the 1000 one.

That's a good point bananas.  If you spend your high-cost-basis coin, then you'd have a capital loss, and, at least in Canada, would not be subject to any reporting requirements.    

When you want to make specific identification you also need to make sure the specific identification of which one you are selling is done verifiably at the time you are selling it,  and be able to prove WHEN you decided and made the record which one you were selling, in order to provide adequate identification ---- typically, this would be done in writing with the broker you use to sell the capital asset.    For example:  to sell a specific lot of stock,  you must identify which basis lot(s) you are selling  before the settlement date of the trade.

It is fine, if you make the decision on the fly, and can prove you did.

Something the IRS says is not allowed though, is to go back to past transactions and re-characterize or re-assign buy/sell  pairs, or change your accounting method later, in order to reduce or defer tax  for  transactions before the decision.




In the US; there can also still be reporting requirement, even when there is a loss or  wash.   Further... if you 'borrow' some Bitcoins from a bank and spend them  -- that activity may be considered a constructive sale  of  Bitcoins  in your other wallet.

[Peter R]

When you want to make specific identification you also need to make sure the specific identification of which one you are selling is done verifiably at the time you are selling it,  and be able to prove WHEN you decided and made the record which one you were selling, in order to provide adequate identification

This is an advantage of the ZGL wallet.  It performs automatic coin control to ensure zero capital gain/loss on day-to-day purchases, while keeping private records of all transactions.  

In the US; there can also still be reporting requirement, even when there is a loss or  wash.  

We need legal confirmation on this point as applied to ZGL.  Upon my preliminary research, I believe you are required to report the events where you realized a gain, and should keep private records of the ones that were a wash.  

On reddit, it was argued that filling 3,000 (ZGL) transactions would be considered a "frivolous filing" and that you would be subject to the $5,000 Frivolous Filing Fine.  


Once again: this is not legal advice.  IANAL.  

[Anon136]

As Jonathan strode through the town he immediately noticed a
dignifi ed well-dressed man kneeling in the street, trying pain-
fully to walk. Yet, the man didn’t appear to be crippled – just short.
Jonathan offered a helping hand, but the man brushed him aside.

“No, thank you!” said the man, wincing in pain. “I can walk
okay. Using knees takes some getting used to.”

“You’re okay? But why don’t you get off your knees and walk
on your feet?”

“Ooooh!” moaned the man, squirming in discomfort. “It’s a
minor adjustment to the tax code.”

“The tax code?” repeated Jonathan. “What’s the tax code have
to do with walking?”

“Everything! Ow!” By now the man settled back on his heels,
resting from his torturous ordeal. He pulled a handkerchief from
his shirt pocket and mopped his brow. He shifted his balance to
massage one knee, then the other. Many layers of worn-out patches
had been sewn on at the knees. “The tax code,” he said, “has
recently been amended to level the fi eld for people of different
heights.”

“Level the fi eld?” asked Jonathan.

“Please stoop over so I don’t have to shout,” pleaded the man.

“That’s better. The Council of Lords decided that tall people have
too many advantages.”

“Advantages of tallness?”

“Oh, yes! Tall people are always favoured in hiring, promotion,
sports, entertainment, politics, and even marriage! Ooooh!” He
wrapped the handkerchief around the newest of many rips in his
grey pants. “So the Lords decided to level us with a stiff tallness
tax.”

“Tall people get taxed?” Jonathan glanced sideways and felt his
posture begin to droop.

“We’re taxed in direct proportion to our height.”

“Did anyone object?” asked Jonathan.

“Only those who refused to get on their knees,” the man said.

“Of course, we’ve allowed an exemption for politicians. We usually
vote tall! We like to look up to our leaders.”

Jonathan was dumbfounded. By now, he found himself slouching,
self-consciously trying to shrink. With both hands pointing down at
the man’s knees he questioned incredulously, “You’ll walk on your
knees just for a tax break?”

“Sure!” replied the man in a pained voice. “Our whole lives are
shaped to fi t the tax code. There are some who have even started to
crawl.”

“Wow! That must hurt!” Jonathan exclaimed.

“Yeah, but it hurts more not to. Ow! Only fools stand erect and
pay the higher taxes. So, if you want to act smart, get on your knees.
It’ll cost you plenty to stand tall.”

Jonathan looked around to see a handful of people walking on
their knees. One woman across the street was slowly crawling.
Many people scurried about half-crouching, their shoulders hunched
over. Only a few walked proudly erect, ignoring the sanctions
completely. Then Jonathan caught sight of three gentlemen across
the street sitting on a park bench. “Those three men,” indicated
Jonathan. “Why are they covering their eyes, ears, and mouths?”
“Oh, them? They’re practising,” replied the man as he leaned
forward on his knees to shuffl e along. “Getting ready for a new
series of tax proposals.”

[Anon136]

Only a few walked proudly erect, ignoring the sanctions completely.

That's a nice story, and I understand the point completely, but the majority of the population isn't ready to protest taxes.

Bitcoin is a nice stepping stone towards freedom, it's an asset that the private key holder has complete control over. So, maybe these taxpayers start using Bitcoin today to enjoy some of it's advantages, and then later on down the road, everyone realizes what it means to have the power of private ownership again.

Mighty oaks from little acorns grow.

it wasnt a commentary on how people should disobey. the point was to show how comical and surreal rational responses to irrational edicts can often be.

so like what i mean is, this whole proposal doesn't actually change anything, its a completely meaningless act, paying from this address or that makes no difference (in the real world, i guess it matters to government), and the effort being put in to controlling your coins properly doesnt help feed the poor or cloth the sick or w/e else. Every bit of effort one puts into controlling their coins for this purpose is productive effort that is being thrown into a black hole, never to be seen again, effort that could have been used alternatively to address number of aspects of society which are less than ideal.

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees. thats not a criticism of people who walk on their knees, its rational for them to do so. what it is is a criticism of anyone who intellectually supports the conditions which lead to such zany and wasteful behavior. This sort of wasted potential energy is precisely why some societies are so much wealthier than others, think hong kong and cuba, singapore and hati. This is the sort of crap that is exactly why these societies are so materially different from one another and here it is, right here at home.

[allenove]

I American IRS behavior was very dissatisfied, they do not admit that BTC is the official currency but also to collect his property tax.

[Peter R]

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees.

I see it as walking on our knees and standing tall at the same time.  

Work on the ZGL wallet is productive in terms of changing perceptions: for example, the proposed use of the mixer to recognize capital gains events legitimizes such devices as a tool to ensure US tax compliance.  This has the advantage of diffusing coin particles more quickly throughout the economy, weakening arguments against bitcoin's fungibility.  This also further reinforces the concept of bitcoin as token money (http://en.wikipedia.org/wiki/Token_money) with strong privacy properties and the notion that ownership belongs to he who controls the private key.  

To get from A to B, we have a lot of myths to shatter.  We will do this one step at a time by jumping through certain hoops and walking around others.  

[acoindr]

Disclaimer: I am not a lawyer and this is not tax advice.

I don't see why ZGL support couldn't be added as a feature for Armory, or any other wallet for that matter.  It requires detailed coin control, but from the user perspective the complexity can remain entirely hidden.  

Not entirely. The way I see it working a user would need to jot a note of every transaction with the software, and probably keep a physical receipt too. The wallet would keep its own ledger of coin identifications, which coins were received when, for how much, and which were spent when and for how much.

The wallet would need to have real-time BTC price data from a source that the IRS would deem reliable, ...

Not really. According to the Wall Street Journal's Q&A the fair market value of coins can be determined by a listed exchange rate based on supply and demand, which is consistently applied. Choosing any large Bitcoin exchange as a data source should be fine.

... and it would need a way to occasionally realize capital gains on "low cost basis" coins.

I don't see why. You wouldn't realize a capital gain or loss on coins until some transaction. The wallet IMO should have an informative interface showing how much in total capital gains or losses a user had at any given time, given the current exchange rate. There would be actual capital gains and potential capital gains (or loss), the actual ones being records of noted transactions which took place.

By checking the Capital Gain Tracker a user could make informed decisions about when to purchase or sell coins (or market goods and services) for tax benefit. For anyone thinking this is an unfair tax loophole scheme I'd argue it's not. Sales tax on purchases would still apply, and probably not be under reported since customers would prefer a receipt for their own tax records. From the property owner (Bitcoin holder) perspective it's simply smart asset management, with diligent record keeping. There is no law against that.

I think the most effective way to realize a capital gain for tax purposes is to use a coin mixer.  You would send 1 BTC + fee into the mixer and receive a new 1 BTC coin sharing 0 taint with the original coin.  Since this is a new piece of property exchanged at arm's length, you are required to recognize the capital gain on this "low cost basis" coin you sent into the mixer at the moment of the exchange.

If you wanted to force a realized capital gain (or loss) I agree this should work. The new property received would enter the wallet system at the current fair market exchange rate.

When you want to make specific identification you also need to make sure the specific identification of which one you are selling is done verifiably at the time you are selling it,  and be able to prove WHEN you decided and made the record which one you were selling, in order to provide adequate identification ---- typically, this would be done in writing with the broker you use to sell the capital asset.    For example:  to sell a specific lot of stock,  you must identify which basis lot(s) you are selling  before the settlement date of the trade.

It is fine, if you make the decision on the fly, and can prove you did.

That's the whole point of the wallet, to keep track of and intentionally use certain pieces of property (coins) at different times. Making notes of the transaction with the wallet software along with keeping physical receipt records should suffice.

In the US; there can also still be reporting requirement, even when there is a loss or  wash.  

We need legal confirmation on this point as applied to ZGL.  Upon my preliminary research, I believe you are required to report the events where you realized a gain, and should keep records of the ones that were a wash.

I believe that's correct. The U.S. tax system is sold as "voluntary compliance", meaning tax payers self report what they owe and how they concluded that. The catch is you have to be correct in the event of an audit or possibly face back penalties and interest. This is where keeping good records comes in. A person who can produce detailed records has a good basis for an argument, even if they made a mistake, although tax could still be due.

On reddit, it was argued that filling 3,000 (ZGL) transactions would be considered a "frivolous filing" and that you would be subject to the $5,000 Frivolous Filing Fine.

I don't believe that applies. Definition of the word frivolous: not having any serious purpose or value. That's the opposite of the detailed transaction records the ZGL wallet creates.

http://www.law.cornell.edu/uscode/text/26/6702

26 U.S. Code § 6702 - Frivolous tax submissions

(a) Civil penalty for frivolous tax returns
A person shall pay a penalty of $5,000 if—
(1) such person files what purports to be a return of a tax imposed by this title but which—
(A) does not contain information on which the substantial correctness of the self-assessment may be judged, or
(B) contains information that on its face indicates that the self-assessment is substantially incorrect, and ...

[Peter R]

Disclaimer: I am not a lawyer and this is not tax advice.

I'm not sure you are following the idea behind the ZGL wallet.  It's purpose is to recognize larger "taxable gain" events on a weekly, monthly or as needed basis, such that all day-to-day spending is provably zero gain/loss.  This helps to ensure compliance with US tax laws.   

Sending the IRS filings that contain frivolous information is a frivolous filing.

[Anon136]

When i see proposals like this, in my mind what i see is someone proposing that we should walk on our knees.

I see it as walking on our knees and standing tall at the same time.  

Work on the ZGL wallet is productive in terms of changing perceptions: for example, the proposed use of the mixer to recognize capital gains events legitimizes such devices as a tool to ensure US tax compliance.  This has the advantage of diffusing coin particles more quickly throughout the economy, weakening arguments against bitcoin's fungibility.  This also further reinforces the concept of bitcoin as token money (http://en.wikipedia.org/wiki/Token_money) with strong privacy properties and the notion that ownership belongs to he who controls the private key.  

To get from A to B, we have a lot of myths to shatter.  We will do this one step at a time by jumping through certain hoops and walking around others.  

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

[Peter R]

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

No offense taken.  I quite enjoyed your story and agree that it shows the irrationality of current tax law.  

[acoindr]

Disclaimer: I am not a lawyer and this is not tax advice.

I'm not sure you are following the idea behind the ZGL wallet.  It's purpose is to recognize larger "taxable gain" events on a weekly, monthly or as needed basis, such that all day-to-day spending is provably zero gain/loss.  This helps to ensure compliance with US tax laws.   

I'm not sure I understand what you're saying here. According to the Wall Street Journal's Q&A on the IRS guidance any transaction with the coins would (or I should say could) be a taxable gain (or loss) event.

Q-6:  Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

A-6:  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. ...

We might be saying the same thing, but to clarify, what I'm saying is I see the ZGL wallet as recording all relevant tax activity surrounding coins. For example, it starts at 0, but when it receives coins they are marked with the current exchange rate for tax basis. Depending on what the exchange rate does, a user could decide whether to make a real world purchase or delay it for tax benefit. If the exchange rate rose they would have a capital gain if the fair market value of what they were "purchasing" (exchanging for their coins) was commensurate, or in other words had a value which exceeded the original lower cost basis. That's a complicated way of saying the bitcoin sale was pegged to U.S. dollars.

In order to offset that capital gain the wallet could also hold coins purchased at a higher rate reflecting a capital loss relative to the exchange rate at the time of the purchase. By using a calculated portion of each of these higher and lower cost basis coins the final trade would result in a capital gain and loss of exactly zero.

Since shopping habits and coin purchases can be haphazard, I see the wallet as maintaining some amount of capital gain or loss at any given time, which could prompt users to adjust their behavior accordingly for beneficial tax effect.

Again, we might be saying the same thing. The part where you lose me is when you talk about calculating events on a weekly, monthly, etc. time frame, because that's not a way I see it working unless users spending habits followed that structure. Every single trade is potentially a capital gain or loss event no matter when it occurs. However, the wallet could track all that info and behave such that over time against a backdrop of volatile exchange rates a user could end up with marginal capital gain or loss, with fairly little effort.

Sending the IRS filings that contain frivolous information is a frivolous filing.

I agree. We are saying the same thing here.

[Peter R]

Again, we might be saying the same thing. The part where you lose me is when you talk about calculating events on a weekly, monthly, etc. time frame, because that's not a way I see it working unless users spending habits followed that structure. Every single trade is potentially a capital gain or loss event no matter when it occurs. However, the wallet could track all that info and behave such that over time against a backdrop of volatile exchange rates a user could end up with marginal capital gain or loss, with fairly little effort.

I think we are beginning to see things similarly.  

What I mean is that eventually you will run out of coins purchased at a "high cost basis".  You will only have "low cost basis" coins in your ZGL wallet.  If you spend a "low cost basis coin" to purchase a coffee you would recognize a taxable gain.  It may be difficult to ensure compliance with US tax laws under such circumstances as you could be making over 10 such purchases per day.  

Instead, when your wallet runs out of "high cost basis" coins, your wallet would automatically recognize a "lump sum" capital gain by swapping "low cost basis" coins for new coins using a mixing service.  You would report these transactions since they resulted in a capital gain.  

But now your wallet can continue forging ZGL coins which are "current" in the sense that the moment you spend them, your cost basis is exactly equal to their current market price.  

The ZGL method is advantageous to both the filer and to the IRS.  It reduces your paper work without affecting the accuracy of your private records (in fact you now keep better records than ever!), and it reduces the paper work that the IRS has to process.  

In my opinion, if you sent a report to the IRS that documented 3,000 tiny transactions, where each one has a gain of exactly zero, I think they may view this as "an attempt to protest" and fine you $5,000.  

It may appear you are launching a DoS attack, for lack of a better term.  

[bitcoiner49er]

Assuming you have enough coins to spread your spending such that it would zero in regards to taxes, would you actually be better off doing so?

Example: Purchasing a $1000 item when BTC value is $1000 will require 1 BTC. If you wait until the event becomes a negative gain (again in regards to taxation), you obviously save USD in terms of taxes, but end up paying more in BTC.

At the end of each tax year, you may have saved paying taxes in USD, but robbed yourself of BTC that may or may not equal the value saved in taxes. Obviously this depends on the value of BTC, but if you subscribe to an ever increasing value for BTC over the long term, you may actually benefit from paying taxes, vs spending more BTC to create negative gain events.

[Anon136]

Don't get me wrong. The purpose of my post is not to marginalize your contribution. This is great work you are doing. As stated previously, I don't fault people for walking on their knees, it's perfectly rational.

No offense taken.  I quite enjoyed your story and agree that it shows the irrationality of current tax law.  

It was a chapter from "The Adventures of Jonathan Gullible" by Ken Schoolland.

[Peter R]

Assuming you have enough coins to spread your spending such that it would zero in regards to taxes, would you actually be better off doing so?

Example: Purchasing a $1000 item when BTC value is $1000 will require 1 BTC. If you wait until the event becomes a negative gain (again in regards to taxation), you obviously save USD in terms of taxes, but end up paying more in BTC.

At the end of each tax year, you may have saved paying taxes in USD, but robbed yourself of BTC that may or may not equal the value saved in taxes. Obviously this depends on the value of BTC, but if you subscribe to an ever increasing value for BTC over the long term, you may actually benefit from paying taxes, vs spending more BTC to create negative gain events.

If you trade your bitcoins and realized a gain as measured in USD on the trade, then you have a taxable gain.  The ZGL wallet doesn't change this fact.  ZGL is simply a tool to ensure compliance with US tax law.  Also, there is never a need to "wait until the event becomes a negative gain" with ZGL. 

If you want to keep more bitcoin, then keep more bitcoin!

[acoindr]

What I mean is that eventually you will run out of coins purchased at a "high cost basis".  You will only have "low cost basis" coins in your ZGL wallet.  If you spend a "low cost basis coin" to purchase a coffee you would recognize a taxable gain.  It may be difficult to ensure compliance with US tax laws under such circumstances as you could be making over 10 such purchases per day.  

Instead, when your wallet runs out of "high cost basis" coins, your wallet would automatically recognize a "lump sum" capital gain by swapping "low cost basis" coins for new coins using a mixing service.  You would report these transactions since they resulted in a capital gain.  

Okay, now I understand what you're talking about. That won't work. You're saying the wallet is set up where the coins you spend are always spent at a time when their value with respect to U.S. dollars has declined, so that there is no capital gain on the trade and nothing to report. There are two problems with that. First, it's possible for the exchange rate, overall, to keep increasing during your spending period. Second, the IRS won't take your word for it there was no capital gain, like teachers in school they want you to "show your work".

But now your wallet can continue forging ZGL coins which are "current" in the sense that the moment you spend them, your cost basis is exactly equal to their current market price.  

There is no way you could do that, because nobody and no software can predict what the market price will be at any time in the future.

The ZGL method is advantageous to both the filer and to the IRS.  It reduces your paper work without affecting the accuracy of your private records (in fact you now keep better records than ever!), and it reduces the paper work that the IRS has to process.  

The way I envision it that's quite possible. Software can produce extremely precise and organized reporting.

In my opinion, if you sent a report to the IRS that documented 3,000 tiny transactions, where each one has a gain of exactly zero, I think they may view this as "an attempt to protest" and fine you $5,000.  

It may appear you are launching a DoS attack, for lack of a better term.  

That's not how it works. I think you said you were not from the US? In fact this is the problem you quoted from that Georgetown Law professor, Levitin:

http://www.theatlantic.com/technology/archive/2014/03/why-bitcoin-can-no-longer-work-as-a-virtual-currency-in-1-paragraph/359648/

It's the fact that every single bitcoin trade can be viewed as a taxable gain or loss event, with them classified as property, which causes Levitin to argue they are now unworkable as currency. That's why Bitcoin Foundation's legal counsel says the classification results in unrealistic and cumbersome reporting requirements.

Average people are generally not meticulous enough to keep up with every property trade they perform, especially when that property behaves more like a currency. Add to that potential capital gains to report and you end up with a potential financial accounting nightmare for Bitcoin currency users. The idea you have about offsetting gains with losses though using smart software decisions counters that. What I'm saying is in addition the software, if designed intuitively, can also make the accounting and documentation effortless. It's a double win.

Regardless of any ZGL wallet Bitcoin users would be expected to show capital gains (or losses) on every bitcoin transaction. Even if those were all at a loss transaction documentation should still be made and records kept in case of audit. That's how it works in the U.S.

[tacotime]

I don't think this would work. This tax attorney advises using the FIFO method and nothing else for bitcoins.

The biggest issue for most bitcoin users is determining their basis. Because bitcoins are fungible, you run into the problem of tracing the cost of each bitcoin you hold. You cannot just arbitrarily choose your basis. The IRS will permit you to use the FIFO method (First in, First out). Any other method such as LIFO or Average Cost Basis is not advisable, particularly now that we know foreign currency rules do not apply

I doubt you're bound to FIFO, as no other US industries are.  They're trying to eliminate LIFO in general by law, but as long as a mining company for precious metals is allowed to make use of it, it seems appropriate for Bitcoins so long as it's used consistently.

[Bit_Happy]

It is possible to design a wallet that automatically organizes your transactions...

I read the OP, but not the whole thread.
Is anyone working on this yet?

[smooth]

Okay, now I understand what you're talking about. That won't work. You're saying the wallet is set up where the coins you spend are always spent at a time when their value with respect to U.S. dollars has declined, so that there is no capital gain on the trade and nothing to report.

He's not proposing that. You need to go back and reread the OP. There will still be capital gains, just not on every single little transaction. There would be a smaller number of transactions with larger gains, not altogether different from cashing in shares of an appreciated mutual fund once per month and then spending that money out of your checking account, as opposed to using a debit card and charging lots of little transactions directly to the mutual fund (each of which would be a taxable event).

The ZGL wallet function is like the checking account here. There might be a small amount of tax avoidance (in some cases, though in other cases taxes might increase), but that is minimal compared to the reduction in taxable events.

[Peter R]

@ acoindr

I think you are still misunderstanding how ZGL works.  You said that each purchase cannot be guaranteed to be zero gain/loss but it can.  Just check out my example in the OP.  As long as the wallet knows the bitcoin price at the time of purchase, and as long as the wallet controls a sufficient number of coins purchased above and below the current price, it is always possible to create a ZGL coin that has a cost basis exactly equal to the current market price at the time of purchase.  

I discussed Levitin's comments earlier in this thread.  What he says gives further credence to the idea of ZGL coins.  Each bitcoin is a unique piece of property with a different cost basis.  This is what allows you to forge ZGL coins that are "current" at the time of purchase such that they result in exactly zero gain or loss.  

The wallet is keeping the most meticulous records possible, BTW.  It is aware of every detail and can prove every tax-related fact.  

[smooth]

Is it every transaction, or just those $600 or more?

The 600-or-more rule refers to reporting of payments in trade or business (1099s). It has nothing to do with capital gains.

[Kyune]

Assume, for the sake of argument, that a ZGL-wallet will exist sometime down the road, one or more years hence.

What is the IRS's policy regarding switching between FIFO, LIFO, or specific lot approaches between different tax years?  If I think I might want to use a ZGL-type approach sometime in the future (when the wallet tech has evolved to support it), does that mean I need to make sure I use "specific lots" for reporting capital gains on my tax return this year in anticipation of that possibility, despite the additional paperwork hassle it entails, because otherwise the IRS will insist on "locking me in" to FIFO or LIFO if I choose it this year?

[Peter R]

Since technically "bitcoins" are outputs from previous transactions, and one can distinguish between them, you can have a cost basis for each individual output. I see no reason why we should be locked into some arbitrary rule when it comes to capital gains/losses on those individual outputs, then again, I can see that the IRS might not be so sensible.

Since bitcoins are identifiable pieces of "property," Levitin (Georgetown Law Professor) says that each one is treated as unique and with a different cost basis for tax purposes.  I've been doing more research and my understanding is LIFO and FIFO are methods that make it easier for filers.  The IRS is allowing you to use this method because they are nice, but you always have the right to pay tax on your actual gains.  

[acoindr]

Okay, now I understand what you're talking about. That won't work. You're saying the wallet is set up where the coins you spend are always spent at a time when their value with respect to U.S. dollars has declined, so that there is no capital gain on the trade and nothing to report.

He's not proposing that. You need to go back and reread the OP. There will still be capital gains, just not on every single little transaction.

I may still misunderstand exactly what he's proposing, but I don't think I misunderstand the implications of the IRS guidance. Again, regardless of this thread every Bitcoin transaction can be a taxable event. That's what the tax attorney I linked says:

#2 Every bitcoin transaction is taxable.
As I said in my first post, Bitcoin users will have to calculate their gain or loss every time they purchase goods or services with bitcoin. Yes, this is a very onerous burden and creates a significant threat to the widespread adoption of bitcoin. However, this outcome is not very surprising and is consistent with US tax laws. Hopefully the Treasury Department or Congress can be convinced to apply a "personal transaction" exception similar to the one that exists for foreign currency. But for now, this is how it will have to work. ...

... The ZGL wallet function is like the checking account here. There might be a small amount of tax avoidance (in some cases, though in other cases taxes might increase), but that is minimal compared to the reduction in taxable events.

That's just it. It's never a good idea generally, when discussing US taxes, to talk about tax avoidance 

@ acoindr

I think you are still misunderstanding how ZGL works.  

I don't think so, but it's possible.

You said that each purchase cannot be guaranteed to be zero gain/loss but it can.  

I didn't say that. What I disagree with you on is accounting and reporting methodology.

Just check out my example in the OP.  

I did.

Hey, I've got to step out now but I do think this thread/idea has merit!

[romang]

This could be very helpful.

[Peter R]

...every Bitcoin transaction can be a taxable event.

Exactly, it can be.  Like you said before, you realize a capital gain on a bitcoin transaction if the market value of the coins you spend are greater than your cost basis for those coins at the time of purchase.  ZGL just ensures that this is never the case for day-to-day purchases.  You still realize capital gains, just in lump sums instead.  

The ZGL wallet keeps meticulous records of all coin swaps (events where a gain is realized) and all purchases (events that are a wash).  In my opinion, you are required to report the taxable gains but reporting 3,000 transactions that did not result in a gain may appear frivolous.  However, since this information is available, you are welcome to submit this as well.  The point is that ZGL is an effective technique to ensure your compliance with US tax law.  You can provide as much proof of this fact any time you like.  


This is not legal advice.  IANAL.  

[smooth]

#2 Every bitcoin transaction is taxable.
As I said in my first post, Bitcoin users will have to calculate their gain or loss every time they purchase goods or services with bitcoin. Yes, this is a very onerous burden and creates a significant threat to the widespread adoption of bitcoin. However, this outcome is not very surprising and is consistent with US tax laws. Hopefully the Treasury Department or Congress can be convinced to apply a "personal transaction" exception similar to the one that exists for foreign currency. But for now, this is how it will have to work. ...

He's wrong. Every transaction is not taxable. It may be taxable if it produces a gain.

It is trivial to show there is a method, at least in theory, to manage a wallet such that many transactions are not taxable.

Imagine that you purchase small number of coins on a continuous basis (using a robot most likely). You will in all likelihood have a small number of coins with a cost basis exactly matching the current market value at any time (unless the market value is at a new high). When you sell/spend coins with a basis of $498.37 and the current market value is $498.37, the transaction is not taxable. There may be reporting and recordkeeping requirements, but those can easily satisfied by the software. The user does not need to think, "Oh, this cup of coffee costs $3 but it also generates a capital gains tax of $0.37." If the purchase is larger, you will likely not have coins with the same cost basis as the current market value, and will generate a capital gain (or loss), but only on these larger, relatively infrequent, transactions.

If you have a large number of coins with a much lower cost basis, you will definitely have to incur a capital gains tax at some point (in the above example, by selling a block of those coins and giving the funds to the robot to start accumulating your collection of coins). This is not some "magic" method of avoiding capital gains taxes. If it were, you would be correct that it can't work, but it isn't.

The ZGL wallet is a slightly more complex way of doing the same thing.

[smooth]

How will a wallet take this into account for transactions happening in January if a purchase in July puts you into a different tax bracket?

Your tax bracket does not change the calculation of gain-or-loss on the sale of an asset. It only changes the amount of tax calculated on the gains.

[Peter R]

The problem I'm having now is that capital gains themselves can move you from one tax bracket to the next as far as the amount you own on those capital gains.

How will a wallet take this into account for transactions happening in January if a purchase in July puts you into a different tax bracket?

The purchases are always a wash.  At any given time, there are only two things that matter: your cost basis for the coins in your ZGL wallet, and the current market price.  The cost-basis of any particular coin doesn't change with time.  The wallet is aware of the market price, and combines particular "high" and "low" cost basis coins to create a ZGL coin.  

All of the gains you realize happen when you swap a block of coins to recharge your "high cost basis" coins.  If you swap the coins in January, then you had a taxable event in January.  If you swap more in April, same thing.  At the end of the year, you'll have, say, 8 swaps that you would report capital gains on.  In all cases, you realized a gain for the same reason: capital gain on coin swap.  Your wallet can print this out for you since it tracks all the details.


EDIT: LOL, what smooth said! 

[acoindr]

#2 Every bitcoin transaction is taxable.
As I said in my first post, Bitcoin users will have to calculate their gain or loss every time they purchase goods or services with bitcoin. Yes, this is a very onerous burden and creates a significant threat to the widespread adoption of bitcoin. However, this outcome is not very surprising and is consistent with US tax laws. Hopefully the Treasury Department or Congress can be convinced to apply a "personal transaction" exception similar to the one that exists for foreign currency. But for now, this is how it will have to work. ...

He's wrong. Every transaction is not taxable. It may be taxable if it produces a gain.

Okay, I can see you disagreeing with me as I'm not a lawyer, but now you're disagreeing with the actual tax attorney quoted by Business Insider as well as a Georgetown Law professor. You really think you're seeing something they don't?

Let me try to explain it this way. Gold is in the exact same situation as Bitcoin. Gold is viewed as property instead of currency. If you exchange gold for other property you can also realize capital gains and losses.

Technically, anytime this happens you're supposed to report any gains. If you're in the business of regularly exchanging gold for other property you should have an accounting system which assesses the value of gold at the time of trade versus the fair market value, in U.S. dollars, of the good or service being acquired.

It's not simply enough to tell the IRS, oh, well due to the way we buy our gold we never have any capital gain events. That's not how it works. It's because you're doing something outside the dollar system that raises the scrutiny, which could very well result in an audit. If you are audited the auditor will tell you what may have resulted in capital gains. Since, again, you're transacting outside the U.S. dollar system with property having a value which fluctuates every transaction is within question for the audit. If you want to then show your lump sum purchase history and think that will fly, good luck. My opinion is it won't, and I believe that's what these actual tax experts are explaining when they say every transaction should be documented and assessed.

[smooth]

It's not simply enough to tell the IRS, oh, well due to the way we buy our gold we never have any capital gain events.

Stop this straw man. Nobody claimed this means never having capital gains events. It means choosing specific lots such that capital gains events, but not necessarily (or even at all) the amount of capital gains, are (greatly) reduced.

You realize that specific lot identification is used to calculate capital gains for billions if not trillions of dollars assets each year, right? This is nothing new to bitcoin.

[Peter R]

...

Again, I think you are misunderstanding how ZGL works.  ZGL is an accounting system to ensure compliance with US tax laws.  It doesn't magically avoid capital gains.  It is a system for efficiently and accurately tracking them.  

If you have an audit, they will see that you reported all capital gains that you realized.  That is the point of the system: it automatically records all of your capital gains in such a way that you can easily file your taxes.  If you are audited, they will see that indeed you did everything correctly.  

 

[acoindr]

It's not simply enough to tell the IRS, oh, well due to the way we buy our gold we never have any capital gain events.

Stop this straw man. Nobody claimed this means never having capital gains events.

Well, it's whatever you meant then. I (as well as the tax attorney) say every transaction counts for documentation; you said that's wrong.

You realize that specific lot identification is used to calculate capital gains for billions if not trillions of dollars assets each year, right? This is nothing new to bitcoin.

My argument is not against specific lots. My view is that's a valid technique. What we seem to disagree on is what the government is likely to view as potential taxable events.

Again, I think you are misunderstanding how ZGL works.  ZGL is an accounting system to ensure compliance with US tax laws.  It doesn't magically avoid capital gains.

I didn't say it avoided capital gains. Once again, my disagreement with you is only over the accounting and reporting methodology, not whether or not specific lots can be used to offset capital gains.

If I can't get you to grasp what I've explicitly stated is what I disagree with you on I don't see any usefulness in continuing the back and forth, especially since neither of us are tax experts.

[Peter R]

I didn't say it avoided capital gains. Once again, my disagreement with you is only over the accounting and reporting methodology, not whether or not specific lots can be used to offset capital gains.

Am I understanding you correctly that you are wondering if you make a trade and realize exactly zero gain if you are required to report it?

(Of course, ZGL documents everything and gives you the ability to report it if you choose but I think doing so may appear frivolous.)

[acoindr]

I didn't say it avoided capital gains. Once again, my disagreement with you is only over the accounting and reporting methodology, not whether or not specific lots can be used to offset capital gains.

Am I understanding you correctly that you are wondering if you make a trade and realize exactly zero gain if you are required to report it?

(Of course, ZGL documents everything and gives you the ability to report it if you choose but I think doing so may appear frivolous.)

Let me ask you something. Are you a U.S. citizen?

[acoindr]

Aaaand silence ...

[smooth]

Well, it's whatever you meant then. I (as well as the tax attorney) say every transaction counts for documentation; you said that's wrong.

What I said was wrong is that every transaction is "taxable" because there are reasonable methods of conducting transactions using specific lot identification such that there is no gain or loss on routine day-to-day transactions, and people engaging in these transactions can routinely ignore the tax consequences, because there aren't any. In some abstract theoretical sense these transactions may still be "taxable" but for all practical purposes they are not, because the tax on a gain or loss of $0 is $0.

No one is suggesting that you purge transaction histories from your wallet or otherwise fail to document or report anything you are required to report.

I didn't say it avoided capital gains. Once again, my disagreement with you is only over the accounting and reporting methodology, not whether or not specific lots can be used to offset capital gains.

Then you didn't read his original post. He explained how specific lots can be used to offset capital gains such that routine day-to-day transactions do not generate capital gains. Everything continues to be documented.

[Peter R]

Sorry acoindr, I was working on something else.  I've stated my citizenship at least twice in this thread, and several times in my post history.  

I really can't determine what your objection is.  Some people seem to object to the "lot identification" idea, but you seem to be fine with this. The only uncertainty I have (and it is quickly fading) is whether there is a reporting requirement if you trade/sell your personal property and have zero capital gain.  I think the answer is "no" because if the answer was "yes" then you'd be required to report every time you sell something on Craigslist and didn't make a gain.  It is my understanding that you only need to report a capital gain if you have a capital gain, and not if you have a wash or a loss.  

Here is discussion on this topic from this thread:

Let's assume a ZGL wallet exists and is functional.

Will these wash transactions need to be reported to the IRS? Obviously, it makes no sense to report them, but I've never known bureaucracy to make much sense. I'm assuming they will want to actually see the capital gains offset the capital losses, but I don't like assuming things.

My thinking is that spending ZGL coins would not be subject to any reporting requirements, although I'd like to hear DeathAndTaxes or BCB's opinion on this matter.  There is provably zero gain/loss on each transaction.  If you have a capital loss (or zero gain) on a normal transaction, at least here in Canada, you aren't required to report it.  

If you were audited, then you'd have a paper trail that proves the transactions were all zero gain/loss and that you were correct in reporting nothing.  

To readers: I am not a lawyer, accountant or tax specialist.  

The IRS WILL audit when you claim you dont have any capital gain.

If there is no capital gain, is there anything to claim?

In the US; there can also still be reporting requirement, even when there is a loss or  wash.  

We need legal confirmation on this point as applied to ZGL.  Upon my preliminary research, I believe you are required to report the events where you realized a gain, and should keep private records of the ones that were a wash.  

On reddit, it was argued that filling 3,000 (ZGL) transactions would be considered a "frivolous filing" and that you would be subject to the $5,000 Frivolous Filing Fine.  

Once again: this is not legal advice.  IANAL.  

[acoindr]

... and people engaging in these transactions can routinely ignore the tax consequences, because there aren't any.

I acknowledged not being a lawyer before making my tax remarks. Peter R had the good sense to do the same, but I haven't seen that from you. For you to make the statement above I find it troubling, that is unless of course you are a lawyer or tax professional.

Sorry acoindr, I was working on something else.  I've stated my citizenship at least twice in this thread, and several times in my post history.  

That's why I asked. I thought I'd read something about it. So you're from Canada.

Regardless of the myriad of words from each of us, you don't see anything peculiar about keeping up an argument against a U.S. citizen that has actually been in the country's tax system for decades, as a Canadian?

[chriswilmer]

Brilliant!

[Peter R]

Sorry acoindr, I was working on something else.  I've stated my citizenship at least twice in this thread, and several times in my post history.  

That's why I asked. I thought I'd read something about it. So you're from Canada.

Regardless of the myriad of words from each of us, you don't see anything peculiar about keeping up an argument against a U.S. citizen that has actually been in the country's tax system for decades, as a Canadian?

I wasn't really looking at it as an argument.  The purpose of this thread was to propose the ZGL idea and get feedback from the community--yours included.  I think we have made good progress so far.

I think this may be difficult for some American's to understand, but many non-American's write posts from a US perspective in order to appeal to the largest audience.  I mentioned at least twice that I am from Canada.  

Canada's CRA is similar your IRS in terms of capital gains treatment.  Differences in the behaviour of the ZGL wallet between Canada and the US would be minor, I believe.  ZGL may be useful to those in Canada, the US and probably several other countries as well.  
 

[acoindr]

I wasn't really looking at it as an argument.  

You said, for example:

... In my opinion, you are required to report the taxable gains but reporting 3,000 transactions that did not result in a gain may appear frivolous.

You have repeatedly emphasized this position throughout the thread despite me, and a tax attorney, saying documenting all the transactions is the way it works in the United States. When you express a contradicting position it's called an argument. This isn't necessarily a bad thing. It's not like I feel hostility toward you. It's just I believe accuracy is preferable. To be accurate in a discussion where there are no experts one relies more heavily on the substance of the arguments.

The only thing either of us can offer is our point of view, drawing from whatever resources we each have. All else being equal, and given the subject matter, one would expect a person actually involved in the system in question to have more credibility behind their words, so long as what they said made sense. If I started speaking authoritatively about what is and isn't required for Canadian capital gains reporting I'd personally feel embarrassed if a Canadian citizen joined the discussion who took issue with what I said, let alone think of directly challenging them. How could I possibly be equal in historical knowledge, not being a studied expert.

Now, a U.S. citizen arguing against a U.S. citizen I can see, or a Canadian arguing against a Canadian, but a foreigner arguing against a native on subject matter of the native's country seems silly, absent a special case, like the foreigner having insight as a studied expert. That wasn't the case with you, though.

Canada's CRA is similar your IRS in terms of capital gains treatment.  Differences in the behaviour of the ZGL wallet between Canada and the US would be minor, I believe.
 

See you've done it again. You made an authoritative statement concerning the IRS when the knowledge you should possess naturally doesn't pertain to it. You said "I believe" here but really not elsewhere. When a citizen tries to explain how a system they're familiar with works, if it makes sense you should probably give it some credence.

[Bit_Happy]

Every bit of effort one puts into controlling their coins for this purpose is productive effort that is being thrown into a black hole, never to be seen again, effort that could have been used alternatively to address number of aspects of society which are less than ideal.

I'm feeling this right now.

A black hole is one way to say it.
I am really sorry to see Bitcoin headed down this endless road; A nasty old road with no fork in it.

[smooth]

... and people engaging in these transactions can routinely ignore the tax consequences, because there aren't any.

I acknowledged not being a lawyer before making my tax remarks. Peter R had the good sense to do the same, but I haven't seen that from you. For you to make the statement above I find it troubling, that is unless of course you are a lawyer or tax professional.

Sorry to hear you are troubled by a statement some random guy on the internet makes. Well, no I'm actually not. But if so, you should really pay less attention to what random people on the internet say.

Unless, of course, you want to engage in the conversation with respect to substance. I think that train left about three replies ago, however.

[Peter R]

...

Acoindr, I feel that your last comment was rude and I don't understand why you are being antagonistic now.  

[acoindr]

I give up.

[shawshankinmate37927]

I have a 2 BTC output in my wallet that was purchased for $2 ($1 per BTC)

I have a 2 BTC output in my wallet that was purchased for $2000 ($1000 per BTC)

I need to make a 0.05 BTC payment to someone and the current exchange rate is $500.

How to I properly create the transaction for zero gain/loss, and what is the cost basis of each the new unspent outputs?

You can't reset your basis (or holding period) by trading with yourself, so any change outputs would retain their original basis. Moving your own asset around, for example moving a stock between certificate form and book entry form, does not change your basis.

The outputs that represent spending would have a new basis (to the recipient), and would be a sale by you.

Of course, I am not the IRS. They might see it differently.

But the problem is I have 2 inputs each with vastly different basis, and only one output.  How do I determine how much of the first input was spent and how much of the second input was spent?  Clearly the new output will have to have a new basis that is somehow a combination of the two original inputs.

I suppose it would be treated a bit like if I sold two previous separate stock purchases and then immediately made a new single purchase of the stock at the current price?

For this example we can say that Address X contains BTC that were purchased at a cost basis of $1/BTC and Address Y contains BTC that were purchased at a cost basis of $999/BTC.  (I changed your original cost basis just to make the math a little easier.)  We're going to be spending .05 BTC total, but need to know how many BTC have to come from each address so that the gain from Address X is cancelled out by the loss from Address Y.

We can use a system of equations that contains two equations, in order to solve for the values of the two unknown variables algebraically, which are:

x = amount of BTC to come from Address X
y = amount of BTC to come from Address Y

We know the following values:

CBX = cost basis of Address X, which is $1/BTC
CBY = cost basis of Address Y, which is $999/BTC
CER = current exchange rate, which is $500/BTC
z = amount of BTC being sold or spent

We also know that:

CBX(x) + CBY(y) = CER(z)

and that:

x + y = z

We fill in the known values and are left with two equations...

First equation: 1(x) + 999(y) = 500(.05)
Second equation: x + y = .05

We begin to solve by subtracting y from both sides of the second equation and we have:

x = .05 - y

We now substitute (.05 - y) for (x) in the first equation and we get:

1(.05 - y) + 999(y) = 500(.05)

We can now solve for y:

.05 - 1y + 999y = 25
.05 + 998y = 25
998y = 24.95
y = .025

We can now substitute (.025) for (y) in the second equation and solve for x:

x + (.025) = .05
x = .025

So, in this example, with an exchange rate of $500/BTC, and .025 BTC being spent/sold from Address X, and .025 BTC being spent/sold from Address Y, the gain realized from Address X would be cancelled out by the loss realized from Address Y.

[Dabs]

I'll chime in:

I have 3 outputs, all are 1 BTC, and they are all in different addresses. There is no record of what their value is anywhere, except the time of the block, therefore the value of the BTC at the time of that transaction, which is now reported by blockchain.info.

What I will then do is figure out how much to pay for a product or service or an exchange to fiat, and determine the BTC value accordingly.

Then I can make 3 separate transactions, spending all of each 1 BTC output, going into new 6 addresses, 1 each for the desired or estimated amount, and 1 each for each change. Once confirmed, blockchain.info will now show a record of those transactions and the BTC value at the time of those transactions.

Then I can spend all 3 of those to the payment address of the merchant for their product or service, or to anyone else for fiat value. The change in the change addresses are simply kept to be used for future purposes.

But, for a lot of people, no one knows who owns what coins in many addresses, and most coins are not under the jurisdiction of the IRS because the holders of the private keys are not US Citizens.


On an different tangent, if I were a US Citizen, subject to the IRS, but my bitcoins were stored in an exchange or online wallet, where I do not have control of the private keys (bad idea), do I own those coins? Can anyone calculate the gains or losses when my coins are continuously being mixed with everyone else?


Finally, if CoinJoin and ShareSend or whatever similar gets widely implemented because it is in a popular wallet client software, how does one even attempt to track everything?

It's very hard for me to pick out a drop of water once it lands in the ocean.

[Peter R]

It's very hard for me to pick out a drop of water once it lands in the ocean.

Lucky for us, bitcoin is not water and our wallets are not an ocean.  

With coin control, we can achieve zero capital gain/lose on our day-to-day expenses, recognizing taxable events in lump sums using an automated coin swap (mixing) service.  Our wallets can track every transactions so that we have rigorous proof of compliance with US tax laws.  We can't do this easily now because the wallets aren't yet available, but the purpose of this thread is to start us moving in the right direction.      

ZGL is a promising technique that simultaneously ensures both our privacy and tax compliance.  We have laid the technical ground work for it in this thread.  The next step is to get legal clarification on the following questions:

1.  Is it acceptable to pay taxes on the actual gains realized when trading/selling your property (i.e., is the lot identification technique acceptable, as opposed to FIFO or LIFO)?

2.  If you exchange property in a single transaction and do not realize a capital gain, is there a reporting requirement?

3.  Is there anything else from a legal perspective that would make the ZGL wallet noncompliant with US tax laws?

I believe the answers are {yes, no, no} but, as I am not a lawyer or tax specialist, I am not qualified to say this with certainty.  

[shawshankinmate37927]

1.  Is it acceptable to pay capital gains on the actual piece of property you are trading/selling (lot identification)?

2.  If you exchange property in a single transaction and do not realize a capital gain, is there a reporting requirement?

3.  Is there anything else from a legal perspective that would make the ZGL wallet noncompliant with US tax laws?

I believe the answers are {yes, no, no} but, as I am not a lawyer or tax specialist, I am not qualified to say this with certainty.

1. I'm not sure what you're asking.  Can you rephrase the question?  (Capital gains aren't paid--income taxes are paid on capital gains.)

2. Not sure if reporting is required on transactions that have no gain or have a loss, but obviously you are required to report the gains.  If you have losses, then it makes sense to report them in order to offset the gains.  I don't think the IRS cares about being informed of every single BTC transaction you made, they just want to know your overall total fiat gain for the year.  I would think that all of the records of gains and losses for each transaction would only be needed to confirm what you are claiming to be your overall gain or loss for the year, if they decided to do an audit.

3. There's nothing illegal about arranging your transactions to minimize your taxes, individuals and businesses do that every day.  But there are other things to consider when it comes to applying income taxes to BTC transactions.  One being, are the gains short-term or long-term?  I believe that property owned for less than one year (short term) is taxed at a higher rate than property owned for more than one year (long-term).  If so, it's best to offset gains with losses in the short term.  Another thing to keep in mind is "wash sales", which apply to shares of stock and perhaps now, BTC.  If you sell property and then buy identical property within 30 days the gain or loss realized on the sale is deferred until the property is sold and stays sold for 30 days or more (I think).

To be clear, I am not a lawyer, an accountant, or an income tax specialist...I'm just putting my thoughts out there.

[Peter R]

3. There's nothing illegal about arranging your transactions to minimize your taxes, individuals and businesses do that every day.  

There seems to be broad consensus on this point.  

2. Not sure if reporting is required on transactions that have no gain or have a loss, but obviously you are required to report the gains.  If you have losses, then it makes sense to report them in order to offset the gains.  I don't think the IRS cares about being informed of every single BTC transaction you made, they just want to know your overall total fiat gain for the year.  I would think that all of the records of gains and losses for each transaction would only be needed to confirm what you are claiming to be your overall gain or loss for the year, if they decided to do an audit.

There seems to be broad consensus that all transactions where a gain was realized would be subject to reporting requirements.  The ZGL technique arranges your transactions so that you realize capital gains in lump sums through coins swaps.  It then arranges your day-to-day spending such that each purchase results in exactly zero gain or loss.  

It seems the biggest point of contention in ZGL is whether there is a reporting requirement for transactions where you don't make a gain (in either case, ZGL logs all these details so that you can prove compliance when ever you choose). The answer is probably the same as the answer to question #3 is below:

1.  If I buy a gift card with a $100 value from Amazon, and then I later use this gift card to make a purchase, would I be required to report the transaction where I consumed the value of the gift card even though I did not incur a gain?  (I know no one would report it, I just want legal clarification).  

2.  If I buy a gold coin from someone on Craigslist for exactly $1300.00 and later sell it for exactly $1300.00, what should I do (I did not incur a capital gain)?

3.  If I bought a gold coin from Person A for exactly $1300.00 and a gold coin from Person B for $1000.00, melted both coins down and forged a new gold coin, and then sold this coin for exactly $2300.00, what should I do (I did not incur a capital gain)?

1. I'm not sure what you're asking.  Can you rephrase the question?  (Capital gains aren't paid--income taxes are paid on capital gains.)

What I originally wrote was incoherent.  I have updated that post to say "Is it acceptable to pay taxes on the actual gains realized when trading/selling your property (i.e., is the lot identification technique acceptable)?"  It seems the consensus is "yes."


I am becoming quite confident that ZGL is not only a fully compliant accounting and reporting technique, but that it would be the technique most preferable to both the IRS and the filer.  The next steps are to seek legal confirmation, write a white paper to clearly detail the ZGL process, and, should legal confirmation be received, write code to integrate a ZGL module into an existing bitcoin wallet.
 

[shawshankinmate37927]

I have updated that post to say "Is it acceptable to pay taxes on the actual gains realized when trading/selling your property (i.e., is the lot identification technique acceptable)?"  It seems the consensus is "yes."

I'm still having a hard time understanding this question.  Sounds like you're asking "Is it okay to pay taxes on my realized gains when I sell/spend BTC?"  Of course it's not just okay, it's required.  But, you are also allowed to report the realized losses during that same calendar year, if you have any, to offset the gains.

Yes, the wallet software would need to keep track of each lot of BTC you purchased/mined and the cost basis of each lot rather than just keep calculating an average cost basis of all your BTC.  (I believe the wallet software would also need to keep track of the date the lot of BTC was purchased/mined since that would determine if you are required to pay the lower rate that is applied to property that was held for over a year or the higher rate that is applied to property that was held for less than a year.)

[Peter R]

I have updated that post to say "Is it acceptable to pay taxes on the actual gains realized when trading/selling your property (i.e., is the lot identification technique acceptable)?"  It seems the consensus is "yes."

I'm still having a hard time understanding this question.  Sounds like you're asking "Is it okay to pay taxes on my realized gains when I sell/spend BTC?"  Of course it's not just okay, it's required.  But, you are also allowed to report the realized losses during that same calendar year, if you have any, to offset the gains.

Yes, the wallet software would need to keep track of each lot of BTC you purchased/mined and the cost basis of each lot rather than just keep calculating an average cost basis of all your BTC.  (I believe the wallet software would also need to keep track of the date the lot of BTC was purchased/mined since that would determine if you are required to pay the lower rate that is applied to property that was held for over a year or the higher rate that is applied to property that was held for less than a year.)

This was referring to the debate about the LIFO, FIFO and lot-identification methods for calculating gains.  I think it has been settled that lot identification is perfectly acceptable. (I.e., since you can identify unique bitcoins, you are not forced to use LIFO or FIFO.  You can pay taxes on the actual gain for each piece of property that you sell.)

[Bit_Happy]

I have updated that post to say "Is it acceptable to pay taxes on the actual gains realized when trading/selling your property (i.e., is the lot identification technique acceptable)?"  It seems the consensus is "yes."

I'm still having a hard time understanding this question.  Sounds like you're asking "Is it okay to pay taxes on my realized gains when I sell/spend BTC?"  Of course it's not just okay, it's required.  But, you are also allowed to report the realized losses during that same calendar year, if you have any, to offset the gains.

Yes, the wallet software would need to keep track of each lot of BTC you purchased/mined and the cost basis of each lot rather than just keep calculating an average cost basis of all your BTC.  (I believe the wallet software would also need to keep track of the date the lot of BTC was purchased/mined since that would determine if you are required to pay the lower rate that is applied to property that was held for over a year or the higher rate that is applied to property that was held for less than a year.)

Nice avatar, and a great movie. 

[shawshankinmate37927]

This was referring to the debate about the LIFO, FIFO and lot-identification methods for calculating gains.  I think it has been settled that lot identification is perfectly acceptable. (I.e., since you can identify unique bitcoins, you are not forced to use LIFO or FIFO.  You can pay taxes on the actual gain for each piece of property that you sell.)

I see...I would actually like to see the wallet software create lots that aren't dependent on the BTC Addresses.  One lot could include BTC from many addresses or one address could be divided up into many lots.

[principalg1]

I like the part which incentivizes buying coins when the price is relatively high. Your downside is essentially covered by future tax breaks. Nice!

What you say I agree with.

[Peter R]

I've added a poll to this thread to get us thinking about whether ZGL transactions should or should not be reported when filing your taxes.  The question relates to gold (physical property that we are familiar with), as I believe this a good analogy to our unanswered question concerning ZGL accounting.  

For new readers, ZGL is a method to realize capital gains over a smaller number of bitcoin swaps, while using coin control to arrange day-to-day purchases such that each transaction provably results in exactly zero gain or loss.  It does not avoid capital gains, it just simplifies their reporting while maintaining the privacy of your  individual purchases.  Refer to the OP for more details.

Of course, the most voted answer may be neither the correct answer nor applicable to bitcoin, so once again this is not legal advice.  
 

[Peter R]

I updated the original post to clarify the concept of ZGL and merge the knowledge we've gathered in this thread. 

Thanks everyone for your contributions!

[Dabs]

It's very hard for me to pick out a drop of water once it lands in the ocean.

Lucky for us, bitcoin is not water and our wallets are not an ocean. 

With coin control, we can achieve zero capital gain/lose on our day-to-day expenses, recognizing taxable events in lump sums using an automated coin swap (mixing) service.  Our wallets can track every transactions so that we have rigorous proof of compliance with US tax laws.  We can't do this easily now because the wallets aren't yet available, but the purpose of this thread is to start us moving in the right direction.     

Okay, for discussion purposes, and I'm really and genuinely curious about this:

A lot of people, whether they should or should not, and just because they can, consolidate their bitcoin holdings to a few addresses. With the advent of coin control, some of these people, not only consolidate different outputs to one bitcoin address, they combine several outputs into one output in one address.

When you do that, the coins are "mixed". It becomes your small puddle of water. Because all the outputs are now 1 giant combined output.

This happens, for example, if I have a lot of dust or a lot of small transactions. Let's say I have one hundred 0.01 outputs. To try to save space on the blockchain an to avoid paying fees, I combine all of those into 1 BTC.

The 100 individual outputs are no longer there. It's just one 1 BTC output.

I run a raffle / lotto, that accepts "bets" into one address, much like the classic Satoshidice used to (or still does?) What I typically do is combine all the unspent outputs into one transaction that pays out to one address their prize.

The typical coin laundry service either spits out outputs from other people. There are others that just simply combine the outputs, so it's not hidden, but the original coins are still mixed; or all coins are "tainted" the same way.

Now, maybe I understand it wrong, but combining outputs, or spending in such a way destroys the "old" coin and makes "new" coins. The individual histories of the value of the coins bought a certain points in time is now "gone." I mean, it's still there, but you can't link it anymore.

Your poll is one example, 1 BTC worth $1200 (for example, bought in December 2013 or January 2014) and another 1 BTC worth $100 (bought some time last year.) Some person decides to spend them using the two outputs and in a transaction turns it into one output now 2 BTC (with no change).

Thus my original quote.

On an unrelated note, there is a similar saying: Every single drop of rain does not think it is responsible for the flood.

[Bit_Happy]

I updated the original post to clarify the concept of ZGL and merge the knowledge we've gathered in this thread. 

Thanks everyone for your contributions!

Thanks for working on these ideas.

[Peter R]

It's very hard for me to pick out a drop of water once it lands in the ocean.

Lucky for us, bitcoin is not water and our wallets are not an ocean. 

With coin control, we can achieve zero capital gain/lose on our day-to-day expenses, recognizing taxable events in lump sums using an automated coin swap (mixing) service.  Our wallets can track every transactions so that we have rigorous proof of compliance with US tax laws.  We can't do this easily now because the wallets aren't yet available, but the purpose of this thread is to start us moving in the right direction.     

Okay, for discussion purposes, and I'm really and genuinely curious about this:

A lot of people, whether they should or should not, and just because they can, consolidate their bitcoin holdings to a few addresses. With the advent of coin control, some of these people, not only consolidate different outputs to one bitcoin address, they combine several outputs into one output in one address.

When you do that, the coins are "mixed". It becomes your small puddle of water. Because all the outputs are now 1 giant combined output.

This happens, for example, if I have a lot of dust or a lot of small transactions. Let's say I have one hundred 0.01 outputs. To try to save space on the blockchain an to avoid paying fees, I combine all of those into 1 BTC.

The 100 individual outputs are no longer there. It's just one 1 BTC output.

I run a raffle / lotto, that accepts "bets" into one address, much like the classic Satoshidice used to (or still does?) What I typically do is combine all the unspent outputs into one transaction that pays out to one address their prize.

The typical coin laundry service either spits out outputs from other people. There are others that just simply combine the outputs, so it's not hidden, but the original coins are still mixed; or all coins are "tainted" the same way.

Now, maybe I understand it wrong, but combining outputs, or spending in such a way destroys the "old" coin and makes "new" coins. The individual histories of the value of the coins bought a certain points in time is now "gone." I mean, it's still there, but you can't link it anymore.

Your poll is one example, 1 BTC worth $1200 (for example, bought in December 2013 or January 2014) and another 1 BTC worth $100 (bought some time last year.) Some person decides to spend them using the two outputs and in a transaction turns it into one output now 2 BTC (with no change).

Thus my original quote.

On an unrelated note, there is a similar saying: Every single drop of rain does not think it is responsible for the flood.

Dabs, it is completely normal to combine your outputs so that the "drops become and ocean" like you said--please don't worry about this.  The coin taint becomes mixed up together, just like how gold atoms get mixed when we melt two coins and re-forge them as one.  If your coins are mixed together and the history has been lost, then for accounting purposes the units become more fungible like money, rather than unique like property.  The truth is that bitcoins can be both unique and fungible.  They can be like drops in an ocean, or like unique pieces of art in a gallery, and we should stir them together or keep them separate to best serve our purposes. 

This post is about leveraging the "uniqueness" property of bitcoins to come up with a simple accounting method for realizing gains when making day-to-day purchases.  There would be other system that would take advantage of the "mixing" property that you pointed out, I'm sure. 

You can add any coins you want to a ZGL wallet and your gains and losses as you spend will get tracked automatically from that day forward using the ZGL technique.  The ZGL wallet just needs to know what to assume as your "cost" for any coins that you give it access to. 

[Dabs]

Well, as a "normal" user of bitcoin, I like to combine all the coins I own into one output every now and then, mostly to avoid paying future transaction fees for very large (in bytes) transactions. The history of those coins do get "lost".

The whole concept of a ZGL wallet is interesting to me, and I might actually use one, just so when the day comes I may need to file any kind of gains or losses, then all I need to do is click "print" and give that to the BIR (the Philippine equivalent of the IRS).

Like you, I'm not in the US, but we keep watch what they do.

So far, our government hasn't said anything about virtual currencies. They also haven't said anything about encryption for the longest time. I keep tabs on the my local government's stand on a few things such as those two and firearms, and since the topic is the United States, a lot of Americans are aware of their 2nd amendment issues.

Slightly off-topic:

I understand Canada is a little bit different (then there is also the government's stand on cannabis). The Philippines is almost a US state, except it isn't. (There are other politics involved, that's another story.) But then you always have Americans coming here, even US forces conducting military exercises, US Navy ships patrolling nearby pretending they don't own what China is claiming ... okay ...

[smooth]

Well, as a "normal" user of bitcoin, I like to combine all the coins I own into one output every now and then, mostly to avoid paying future transaction fees for very large (in bytes) transactions. The history of those coins do get "lost".

The history gets lost in the wallet, but according to the recent IRS guidance, that doesn't let you off the hook for keeping track of the history for tax purposes. You still appear to be required to keep track of the original history to report gains under a FIFO rule or possibly other rules such as using specific lots.

I suppose a wallet could be constructed that would recognize that certain coins are made up of a combined lot of several other lots of coins, and then produce tax-compliant reports accordingly.

I'm not sure whether you can treat the mere act of combining the coins as realizing the gain or loss. I would guess not, but my confidence on that is low.

[Dabs]

As usual, I am reminded of the very old question that gets asked a lot around here. "How many books do you keep?"

There are two important people you need to have: an accountant, for your taxes, and an attorney, for the legal stuff. I keep them separate, but it's not a bad idea to have one person be both (I've seen accountants who are taking up law, and lawyers taking up accounting, and some of my friends have the letters ATTY in front of their name as well as CPA on the end.)

[fryarminer]

I like this concept a lot - the only thing that would make me afraid of it is if it was an online service and not a stand alone program. I would want it to work without an internet connection. How do I know that a wallet designed to help regarding taxes is not reporting to the IRS in the background?
If at the end of the day I could print out my own report and then choose to use it or not use it, the rest of the concept is premium. I like the idea of merging coins purchased at different prices.

[Peter R]

Well, as a "normal" user of bitcoin, I like to combine all the coins I own into one output every now and then, mostly to avoid paying future transaction fees for very large (in bytes) transactions. The history of those coins do get "lost".

The history gets lost in the wallet, but according to the recent IRS guidance, that doesn't let you off the hook for keeping track of the history for tax purposes. You still appear to be required to keep track of the original history to report gains under a FIFO rule or possibly other rules such as using specific lots.

Yes, Smooth made this more clear than I did above.  If your "drops become and ocean," your cost basis for the ocean becomes the weighted-average of the cost basis of the individual drops.  

[Peter R]

I like this concept a lot - the only thing that would make me afraid of it is if it was an online service and not a stand alone program. I would want it to work without an internet connection. How do I know that a wallet designed to help regarding taxes is not reporting to the IRS in the background?

I'm glad to hear that you like the idea.  

In my mind, ZGL becomes simply an (open-source) add-on for existing wallets like Amory, Multibit, Electrum, etc.  So the question is whether you trust these wallets to not report your transactions.

In order to forge ZGL coins, the wallet needs to know the real-time bitcoin price.  This is why the wallet needs a live connection to a "bitcoin price server."  This doesn't mean, however, that the ZGL wallet must be a web-wallet hosted on a server.  The only use case where ZGL doesn't really work is for an off-line Armory wallet, but very few people are making day-to-day purchases using an off-line Armory wallet anyways.  

If at the end of the day I could print out my own report and then choose to use it or not use it, the rest of the concept is premium. I like the idea of merging coins purchased at different prices.

This is precisely the idea.  The wallet would provide two reports:

1.  A report of all the swaps where you realized a taxable gain (or loss).

2.  A report of all your ZGL purchases (where no gain or loss was realized).  

This is your private information and you can do with these reports as you wish.  I believe the current tax law says that you should voluntarily submit #1 to declare your capital gains or losses, but whether you should submit #2 is still up in the air.  

[smooth]

Well, as a "normal" user of bitcoin, I like to combine all the coins I own into one output every now and then, mostly to avoid paying future transaction fees for very large (in bytes) transactions. The history of those coins do get "lost".

The history gets lost in the wallet, but according to the recent IRS guidance, that doesn't let you off the hook for keeping track of the history for tax purposes. You still appear to be required to keep track of the original history to report gains under a FIFO rule or possibly other rules such as using specific lots.

Yes, Smooth made this more clear than I did above.  If your "drops become and ocean," your cost basis for the ocean becomes the weighted-average of the cost basis of the individual drops.  

This is not clear. The question I have is whether "melting down" coins and using those to create new coins is itself a taxable event, or whether you actually have to engage in trade to constitute a taxable event. I think the latter.

[Peter R]

Well, as a "normal" user of bitcoin, I like to combine all the coins I own into one output every now and then, mostly to avoid paying future transaction fees for very large (in bytes) transactions. The history of those coins do get "lost".

The history gets lost in the wallet, but according to the recent IRS guidance, that doesn't let you off the hook for keeping track of the history for tax purposes. You still appear to be required to keep track of the original history to report gains under a FIFO rule or possibly other rules such as using specific lots.

Yes, Smooth made this more clear than I did above.  If your "drops become and ocean," your cost basis for the ocean becomes the weighted-average of the cost basis of the individual drops.  

This is not clear. The question I have is whether "melting down" coins and using those to create new coins is itself a taxable event, or whether you actually have to engage in trade to constitute a taxable event. I think the latter.

Yes, that is the point that is unclear.  

I was just referring to the fact that the cost basis of the "melted down" coin becomes the weighted-average of cost-bases of the inputs (which is true whether or not the "melting process" is a taxable event).

EDIT: thinking about this more, if the "melting process" is a taxable event, then you would potentially have thousands of such events depending on how you split and merge your individual coins, even if you never sell or trade a single satoshi.

EDIT 2: Smooth, I think you may be on to something here.  If modifying your personal property is a taxable event, then many people would be required to report normal everyday events even if they don't sell or trade their property.
 

[smooth]

I was just referring to the fact that the cost basis of the "melted down" coin becomes the weighted-average of cost-bases of the inputs (which is true whether or not the "melting process" is a taxable event).

Maybe. In its guidance the IRS has stated a LIFO rule for virtual currencies. With LIFO even if you melt-and-combine when you do a trade it could be that your cost basis is not derived from either of the coins you melted. If you are able to use the specific lot method, which seems likely but is not clear from the guidance, then the weighted average calculation is correct, but probably have to identify the original purchase date and price if the melting process is not a taxable event (reset of basis).

Also, let's not forget about holding period. LIFO might be more advantageous if it shifts more of your gains into the long-term category. If you buy two coins today, melt them together, and then spend that new coin, the tax treatment might ignore both the purchase and melting and consider your basis and holding period from some coin you bought long ago.

All this remains to be worked out. Some of this (for example preference of long term over short term holdings) could also be implemented in a wallet.

[Peter R]

I was just referring to the fact that the cost basis of the "melted down" coin becomes the weighted-average of cost-bases of the inputs (which is true whether or not the "melting process" is a taxable event).

Maybe. In its guidance the IRS has stated a LIFO rule for virtual currencies.

Thanks for your continued help with ZGL, Smooth.  

May I ask where your read about the LIFO recommendation?  I didn't see LIFO mentioned at least in Notice 2014-21 (http://www.irs.gov/pub/irs-drop/n-14-21.pdf)

Q-5: How is the fair market value of virtual currency determined?

A-5: 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.

Q-6: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

A-6: 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. See Publication 544, Sales and Other Dispositions of Assets, for information about the tax treatment of sales and exchanges, such as whether a loss is deductible.


When I read this, it sounds to me like you should value your coins using market rates and a reasonable and consistent accounting system to calculate your adjusted basis.  I think ZGL is reasonable and it is definitely consistent.  

I still agree we need legal clarity here...

[smooth]

I was just referring to the fact that the cost basis of the "melted down" coin becomes the weighted-average of cost-bases of the inputs (which is true whether or not the "melting process" is a taxable event).

Maybe. In its guidance the IRS has stated a LIFO rule for virtual currencies.

Thanks for your continued help with ZGL, Smooth.  

May I ask where your read about the LIFO recommendation?  I didn't see LIFO mentioned at least in Notice 2014-21 (http://www.irs.gov/pub/irs-drop/n-14-21.pdf)

You are correct. I must have seen LIFO in one of the (apparently inaccurate) second hand reports, but it seems it didn't come from the IRS.

[fryarminer]

Peter R, I'm in. This is an excellent innovation.

[Dabs]

I think ZGL can still work on offline wallets like Armory. It would simply use what it knows at the time you create the transaction, or the offline part will ask the user to input the current bitcoin rate. Or the online part of the ZGL wallet grabs this for you and sends it to the offline part.

Which you can see, since the offline part will have to sign the transaction.

[datafish]

This may be a slightly off-topic question, but imagine if someone creates a unique product or service and sells it on a web site for bitcoin.  They only list the price in bitcoin, and there is no comparable product or service on the market.  If you purchase this item, how would you calculate your capital gains if there is no reference fiat price?  I don't think you can just use the current exchange rate as a basis.  What if this product were made available a year ago and the BTC price never adjusted to reflect the changing exchange rate?

[Dabs]

@datafish, what kind of product or service would that be? Is it truly unique? I think I've seen everything you can possibly call a product or service, and nothing is unique in the sense that all of them are merely variations of something else.

Therefore, there would always be some sort of fiat valuation of it.

Unless you have a completely new invention.

Or you are selling alt-coins.

So how much are the alt-coins worth? What if, instead of buying a product or a service, I trade my BTC to buy LTC? When you open that up, you can also trade BTC for any of the literally hundreds of other coins (no matter how worthless.)

Now, I understand LTC has a price in USD. But most of the other coins do not directly have a fiat price. They are mostly pegged to the bitcoin.

A popular alt is DOGE. It does not have a fiat exchange as far as I am aware. I think LTC has a lot of exchanges available. One of the larger ones is BTC-E, and that does have some other fiat / virtual currency pairs.

[datafish]

@datafish, what kind of product or service would that be? Is it truly unique? I think I've seen everything you can possibly call a product or service, and nothing is unique in the sense that all of them are merely variations of something else.

I don't have anything specific in mind; I was just thinking out loud. What if you used BTC to buy early shares in Mastercoin or Ethereum? There is no clear valuation in a virtual startup on the first day of issuance, is there? Would you pay capital gains sometime later, once the startup becomes successful and you use the proceeds to buy some conventional product or service?

[Peter R]

@datafish, what kind of product or service would that be? Is it truly unique? I think I've seen everything you can possibly call a product or service, and nothing is unique in the sense that all of them are merely variations of something else.

I don't have anything specific in mind; I was just thinking out loud. What if you used BTC to buy early shares in Mastercoin or Ethereum? There is no clear valuation in a virtual startup on the first day of issuance, is there? Would you pay capital gains sometime later, once the startup becomes successful and you use the proceeds to buy some conventional product or service?

For the time being, I think the "answer" you'll receive is that the amount of BTC someone trades converted to $ at the time of the trade is the valuation.  As bitcoin use grows, I think this answer will be seen as computationally ambiguous and will be rephrased to reflect reality.

There is already an area of ambiguity: what if you trade a bitcoin for a bitcoin?  Clearly, if you sell a bitcoin for $ and immediately buy it back, this is a taxable event and if you realized a gain you are required to report it (you can't do this to realize losses however, as time limits apply).  If you sell a bitcoin for litecoin and immediately buy it back, again you may have realized a gain.  If you use a coin swap service to swap your coin for a completely unrelated coin (0% taint), then again you've engaged in trade at arm's length and if you realized a gain then the IRS will gladly accept payment.

But what would the current tax law say about a coinjoin transaction?  If you use a coinjoin transaction to move your coins from A to B (you control both end points), is this a taxable event?  You are engaging in trade with an arm's length party in a sense, but since you retain control (coinjoin is trustless) you never really trade your bitcoins (yet your taint profile changes).  It's ambiguous--there is no physical analog to compare it to.    

To conclude, I think bitcoin is working exactly as it should.  It is showing the complexity and ambiguity of the current tax system and wakes people up to the fact that you cannot be 100% compliant.  If everyone used bitcoin, however, the tax code could be overhauled into a few pages of C++ code.  


I have ideas for how one could create a tax system that is unavoidable (no need to file anything) and completely voluntary at the same time.  But that is the topic for a different thread….

[datafish]

To conclude, I think bitcoin is working exactly as it should.  It is showing the complexity and ambiguity of the current tax system and wakes people up to the fact that you cannot be 100% compliant.  If everyone used bitcoin, however, the tax code could be overhauled into a few pages of C++ code. 

The way I see it, Bitcoin and other open-source, p2p projects are collectively an attempt to overhaul the current political and legal system into a large code base.  We're not there yet, however, and the vested interests will not go without a fight.

[Dabs]

@datafish, what kind of product or service would that be? Is it truly unique? I think I've seen everything you can possibly call a product or service, and nothing is unique in the sense that all of them are merely variations of something else.

I don't have anything specific in mind; I was just thinking out loud. What if you used BTC to buy early shares in Mastercoin or Ethereum? There is no clear valuation in a virtual startup on the first day of issuance, is there? Would you pay capital gains sometime later, once the startup becomes successful and you use the proceeds to buy some conventional product or service?

Yes, I mentioned alt-coins. Those things don't have fiat value yet, but like Peter says, most will consider the fiat value of the bitcoin value as the value of the alt-coin.

So, now there are a ton of alt-coins, and in an attempt to peg a value to them, some are accepting IPOs for pre-mined coins. The fiat value of those coins will therefore be equivalent to the bitcoin value converted to fiat at the time of the transactions.

The value of the coins later goes up or down on it's own, depending on the supply and demand once people start using those coins, trading them, exchanging them, etc. Most are still pegged to the bitcoin. Very few are pegged to any other value.

At least one is trying to disassociate it's own value separate from bitcoin, but using it's own value. Basically the bitcoin value will follow that coin's fiat value, not the other way around.

Only time will tell. All of these coins are much too young to really have any value (but still, people are sending BTC / fiat.)

[smooth]

What if you used BTC to buy early shares in Mastercoin or Ethereum? There is no clear valuation in a virtual startup on the first day of issuance, is there?

Sure there is. Why would you pay BTC for something that isn't worth at least what you paid for it. Why would the seller take BTC that is worth less than what he is selling?  Willing buyer + willing seller = fair market value.

[chriswilmer]

Hey guys,

Sorry if this was discussed already (it's a nuanced question, so it's hard to search for an answer)...

...is coin control really needed for the ZGL concept? I think from the IRS's perspective, you can use the ZGL concept even if your coins/stocks were fundamentally indistinguishable. For example, you can keep track of tax lots when you sell shares of a company, but it's just an accounting abstraction for tax purposes. The shares themselves are not marked in anyway.

So, more concretely, even if you took all of your unspent outputs in your wallet and combined them into a single unspent output, I think you could still apply the ZGL principle for tax purposes... as long as you kept a table of your cost basis for every coin you purchased. This might simplify the design of such a wallet considerably.

Please forgive me in advance if you guys discussed this ages ago.

[smooth]

Hey guys,

Sorry if this was discussed already (it's a nuanced question, so it's hard to search for an answer)...

...is coin control really needed for the ZGL concept? I think from the IRS's perspective, you can use the ZGL concept even if your coins/stocks were fundamentally indistinguishable. For example, you can keep track of tax lots when you sell shares of a company, but it's just an accounting abstraction for tax purposes. The shares themselves are not marked in anyway.

So, more concretely, even if you took all of your unspent outputs in your wallet and combined them into a single unspent output, I think you could still apply the ZGL principle for tax purposes... as long as you kept a table of your cost basis for every coin you purchased. This might simplify the design of such a wallet considerably.

Please forgive me in advance if you guys discussed this ages ago.

Good point. You can use specific lots on book entry shares that are all part of a large pool held by the broker, in fact in some cases for short periods of time the broker may be short shares and "your shares" don't even exist. No matter, as long as you keep track of your trades you can use specific lots.

Using coin control for ZGL seems like overkill. A transaction history by itself might well be enough.