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

[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?

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[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.