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Property Securities Commodities

Property, Securities & Commodities: What’s the Difference?

Learn the difference between three common asset types according to official government definitions.

The crypto ecosystem is a complex and confusing regulatory landscape. While cryptocurrencies have the word “currencies” in the name, the IRS considers them property rather than currency for tax purposes. At the same time, the SEC believes many initial coin offerings are securities subject to registration requirements.

In this article, we’ll explore these terms and what they mean from a tax and regulation standpoint.

The IRS: All Crypto is Property

Property refers to securities, real estate, business assets, or other assets. From a tax standpoint, property has a cost basis that influences taxable gains or losses.

The IRS considers all virtual currencies “property” for tax purposes, including cryptocurrencies, non-fungible tokens (NFTs), and stablecoins. Specifically, the IRS doesn’t consider virtual currencies “fiat” because they are not coin and paper money issued by a central bank. Instead, they are “convertible virtual currencies,” which makes them “property.”

As property, virtual currencies are subject to income and capital gains taxes. For example, taxpayers owe income tax on any virtual currency they receive as compensation. Moreover, they owe capital gains taxes on any increase in value over their cost basis. So, like a stock, you owe taxes on those gains if you buy low and sell high.

Of course, the blanket definition creates plenty of ambiguities. For instance, it’s unclear if wrapped tokens constitute a taxable event. If so, many cross-chain bridges could generate sizable tax bills. While the IRS clarified some of these issues, the remaining ones have resulted in uncertainty and potentially inaccurate tax filings.

The SEC: Some Tokens Are Securities

Securities refer to fungible, negotiable financial instruments that represent some type of financial value, such as a stock or bond.

Initial coin offerings (ICOs) allow projects to raise capital and investors to participate in opportunities. So, not surprisingly, the SEC believes many ICOs qualify as securities offerings. The agency has become increasingly aggressive in pursuing individuals and companies selling unregistered securities or perpetrating securities fraud.

The Howey Test determines whether a transaction qualifies as an “investment contract” and is subject to disclosure and registration requirements. Under the test, an investment contract exists if there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Of course, the Howey Test is challenging to apply to cryptocurrencies. For example, many decentralized crypto projects may not have any common enterprise or “nexus” with the other elements of the test. Moreover, miners usually refrain from participating in any governance or rulemaking endeavors. And developers are typically unincorporated individuals.

The CFTC: All Crypto is a Commodity

Commodities refer to basic goods used in commerce that are interchangeable with other goods of the same type, such as a barrel of oil or ounce of gold.

The launch of Bitcoin futures contracts added another regulator to the mix – the Commodities Futures Trading Commission (CTFC). Under the Commodity Exchange Act, the CFTC insists that all cryptocurrencies are commodities. But while it doesn’t have jurisdiction over the spot market, the agency is responsible for regulating Bitcoin futures contracts.

The agency also has jurisdiction when virtual currencies are used in derivatives contracts or when there’s interstate fraud. For example, the CFTC is responsible for regulating crypto exchanges and ensuring they comply with various reporting requirements. But of course, the agency became the subject of intense criticism after FTX’s collapse.

Enforcement Activity Could Pick Up

The FTX collapse put tremendous pressure on regulators across the IRS, SEC, and CFTC to step up enforcement and protect investors and consumers from fraud. In addition to the SEC, CFTC, and DOJ bringing cases against FTX leadership, Nexo, Genesis, Kraken, Paxos, Terraform Labs, and others faced enforcement actions over the ensuing months.

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Crypto enforcement actions have picked up in recent years. Source: Solidus Labs

Earlier this year, top financial regulators sent a letter to banking organizations warning them to exercise caution in dealing with crypto projects. The Federal Reserve also denied an application from Custodia Bank to join the central bank’s payment system. As a result, crypto companies could find it more difficult to transact with fiat.

The most active regulator has been the SEC’s Gary Gensler. After its lawsuit against Ripple, the agency’s enforcement actions aim to bring crypto firms in line with other financial firms. The agency has also gone after individuals for everything from insider trading to hawking digital tokens for money (e.g., influencer marketing).

Europe’s MiCA Could Offer a Template

The Markets in Crypto Act (MiCA) in Europe could provide a blueprint for what’s next in the U.S. The landmark legislation imposes new requirements on crypto platforms, token issuers, and traders to increase transparency and supervise transactions. The goal is to help protect consumers while promoting a vibrant crypto ecosystem.

MiCA also addresses several other concerns, including:

  • Stablecoins will be required to maintain ample reserves to meet redemption requests in the event of mass withdrawals.
  • Crypto companies will be required to disclose their energy consumption and impact on the environment.
  • Exchanges and other platforms will be required to inform consumers about risks associated with their operations.
  • Providers could become liable if they lose investors’ crypto assets.

Experts believe these new rules will go into effect sometime next year. In the meantime, Congress and other U.S. regulatory bodies could look at the new legislation as a template for their own efforts.

The Bottom Line

The IRS, SEC, and CTFC group crypto assets into various buckets, influencing their tax treatment and regulation. By understanding these classifications, crypto traders, investors, projects, and businesses can ensure compliance and avoid costly penalties. Meanwhile, MiCA and other international regulations could preview what’s to come.

If you’re looking for an easy way to comply with IRS rules, ZenLedger’s platform aggregates transactions across wallets and exchanges, computes capital gains or losses, and generates the tax forms you need to file. You can also access tools to harvest tax losses and support your accountant or tax attorney in the event of an audit.

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Justin Kuepper