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

[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.

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[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.