Flare and Taxes

[brianwalden]

I just made another post with a recent Interview with Hugo. He talked about the FLR airdrop from a tax perspective.

The original 15% airdrop is worth nothing because there's no market yet. Then to claim the remaining 85% you'll have to pay a very small amount of FLR. So you'll basically be buying it for pennies, which will form your basis.

No word yet on F-assets and taxes.

Edited May 22, 2021 by brianwalden

[brianwalden]

Here's @Seoulite's quote of the relevant material:

Ok this is exactly what Hugo says about tax (around 1 hour 10 minutes into the vid):

first he caveats a lot that this is absolutely NOT TAX ADVICE

"We have spoken to a really really really highbrow tax lawyer from Harvard. He's written a memo for us. There's a specific way that you receive the flare distribution, so you receive 15% at zero, and that genuinely is delivered at zero cost. If you want the other 85%, you will be burning some of your spark tokens, not many, not much, they don't have any value, in order to receive that. And that is considered a 'payment', in order to receive the remaining 85%. You've paid for those tokens, basically, at day one, at basically zero value. So that means that you can then, well according to the memo (and again this not tax advice, etc etc etc), essentially that absolves you from, basically you would still be receiving tokens, and you would still essentially be taxable on them, but your basis for the tax is zero. And so you would obviously pay a capital gains tax when you sell them, and that's the same with any asset. 

The IOUs are not anything to do with it. You can't use an IOU as a basis to say there's a price. That would be like saying the derivatives market for the SNP500 in December 2021, that's the price of the SNP500 now, it's just incorrect. [...] So they are delivered at zero value. 

You'll have to burn some spark tokens, but it's not going to be hefty (british translation: a lot, heavy).

Don't quote me on it, we need to release whatever we can release, properly. I simply say that the tax burden is gonna be zero or minimal, rather than trying to give a mechanic on it."

[CountZerpula]

@Seoulite @brianwalden - I moved this here from the other thread so as to keep it on topic 

20 hours ago, brianwalden said:

Unfortunately, the more I figure out how F-assets work, the more I think that converting XRP to FXRP will be a taxable event. Still no official word from Flare though. Maybe they've thought of something - they're usually three steps ahead of everyone else.

If you think about it, they have given us official word:

This is pretty clear. In order to avoid a custodial relationship, you're simply trading one asset for another. This makes it easier from a bookkeeping standpoint as well IMO, as this amounts to one transaction; one line-item entry.

It's more complicated to track assets that remain in your custody that you might move to Celsius, or Power Piggy etc ... in either case you retain custody and, to preserve the cost-basis for those assets, you need to be able to show that they have been removed from the purchase pool, segregated in the collateral module, and then at some point moved back into the purchase pool. If I'm simply trading XRP > fXRP, easy peasy - but moreover, this is exactly what's happening, it's not a 'workaround' - and this is the best way to keep your books.

Pretty well every transaction you make in crypto can be a 'taxable transaction' - at least in the US. Not directed at you, but judging from the commentary on social media, it seems a LOT of people conflate the phrase 'taxable transaction' with 'going to cost me money' ... but that's not always true. You could buy $500K of USDC with USD on Coinbase and, while it would be a 'taxable transaction' - you wouldn't owe any money.

USDC<>USD is always 1:1\$1USD on Coinbase. Whether or not the prices of either asset are really that even out in the rest of the world doesn't matter; that's what they are on Coinbase, and those were the prices on either side of the trade that you completed. You spent $500K USD and bought 500K USDC; there is no gain or loss - but you absolutely need to keep track of the flow of funds in order to preserve cost basis, and keep FIFO intact (or whatever method you use).

So ... yeah, this was actually good news IMO ... it will be interesting to see if the protocol presents a trade from either XRP>fXRP or fXRP > XRP as 1:1 .... To the extent that there might exist a slight degree of variance in how tightly the xFRP/XRP peg is correlated at any given moment, maybe the system swallows the difference in order to present a 1:1 trade XRP > fXRP, similar to the Coinbase transaction I outlined.

[brianwalden]

17 minutes ago, CountZerpula said:

@Seoulite @brianwalden - I moved this here from the other thread so as to keep it on topic 

If you think about it, they have given us official word:

This is pretty clear. In order to avoid a custodial relationship, you're simply trading one asset for another. This makes it easier from a bookkeeping standpoint as well IMO, as this amounts to one transaction; one line-item entry.

It's more complicated to track assets that remain in your custody that you might move to Celsius, or Power Piggy etc ... in either case you retain custody and, to preserve the cost-basis for those assets, you need to be able to show that they have been removed from the purchase pool, segregated in the collateral module, and then at some point moved back into the purchase pool. If I'm simply trading XRP > fXRP, easy peasy - but moreover, this is exactly what's happening, it's not a 'workaround' - and this is the best way to keep your books.

Pretty well every transaction you make in crypto can be a 'taxable transaction' - at least in the US. Not directed at you, but judging from the commentary on social media, it seems a LOT of people conflate the phrase 'taxable transaction' with 'going to cost me money' ... but that's not always true. You could buy $500K of USDC with USD on Coinbase and, while it would be a 'taxable transaction' - you wouldn't owe any money.

USDC<>USD is always 1:1\$1USD on Coinbase. Whether or not the prices of either asset are really that even out in the rest of the world doesn't matter; that's what they are on Coinbase, and those were the prices on either side of the trade that you completed. You spent $500K USD and bought 500K USDC; there is no gain or loss - but you absolutely need to keep track of the flow of funds in order to preserve cost basis, and keep FIFO intact (or whatever method you use).

So ... yeah, this was actually good news IMO ... it will be interesting to see if the protocol presents a trade from either XRP>fXRP or fXRP > XRP as 1:1 .... To the extent that there might exist a slight degree of variance in how tightly the xFRP/XRP peg is correlated at any given moment, maybe the system swallows the difference in order to present a 1:1 trade XRP > fXRP, similar to the Coinbase transaction I outlined.

Just to clarify, you're saying that because we have official word that converting XRP to FXRP is a trade, and not some sort of custodial arrangement, we can then infer that it's a taxable event.

I agree, that was my logic as well. But my logic also said that the remaining 85% of the airdrop would be taxable as income and Flare figured out a way to make it not income and make the expense negligible.

But with what we know now, I think you're right and we should pencil in the conversion to F-assets as a taxable event. If it stays that way, it's going to put a damper on F-assets.

[CountZerpula]

48 minutes ago, brianwalden said:

Just to clarify, you're saying that because we have official word that converting XRP to FXRP is a trade, and not some sort of custodial arrangement, we can then infer that it's a taxable event.

 

49 minutes ago, brianwalden said:

But with what we know now, I think you're right and we should pencil in the conversion to F-assets as a taxable event. If it stays that way, it's going to put a damper on F-assets.

Either scenario I mentioned would create at least one taxable event - in one instance, a simple trade between the two assets, in the other, a series of transactions to track the flow of funds properly; some of which will certainly be tax’able’.

55 minutes ago, brianwalden said:

I agree, that was my logic as well. But my logic also said that the remaining 85% of the airdrop would be taxable as income and Flare figured out a way to make it not income and make the expense negligible.

And the FLR distribution is a different topic altogether. Again, speaking in terms of US tax law, but every aspect of the distribution would be tax’able’, no matter what the distribution mechanics end up being. I’ve listened to that interview as well, and would certainly love to get a look at that memo Hugo is talking about. I have a general idea of what I think might happen, but will wait for them to release more info out ahead of the distribution event before speculating.

[Seoulite]

11 hours ago, brianwalden said:

But with what we know now, I think you're right and we should pencil in the conversion to F-assets as a taxable event. If it stays that way, it's going to put a damper on F-assets.

Not sure I agree with the last statement, as it seems the idea is that you don't jump back and forth between the assets (minting fee) and instead you are doing a relatively small number of jumps over a long period. This would not be much different from trading any other token. And if there is a 1:1 'peg' on some exchanges as @CountZerpula suggests, there would be no tax liability in any case. 

There is incentive at the beginning to mint, and also potential DeFi yields from the F-assets. The con is added tax concern and potential tax liability. But if you hold xrp or ltc or doge you get no pros and no cons. I agree it may put a damper on things to the extent that any amount of friction puts a damper on things, but the benefits outweigh the costs, especially if you are making relatively few transactions.

[brianwalden]

44 minutes ago, Seoulite said:

Not sure I agree with the last statement, as it seems the idea is that you don't jump back and forth between the assets (minting fee) and instead you are doing a relatively small number of jumps over a long period. This would not be much different from trading any other token. And if there is a 1:1 'peg' on some exchanges as @CountZerpula suggests, there would be no tax liability in any case. 

There is incentive at the beginning to mint, and also potential DeFi yields from the F-assets. The con is added tax concern and potential tax liability. But if you hold xrp or ltc or doge you get no pros and no cons. I agree it may put a damper on things to the extent that any amount of friction puts a damper on things, but the benefits outweigh the costs, especially if you are making relatively few transactions.

It doesn't matter that you sell it 1 to 1. If you bought 100K XRP at $.50 and trade them for 100K FXRP when XRP is worth $1, you now have a $50K capital gain.

[CountZerpula]

21 hours ago, brianwalden said:

It doesn't matter that you sell it 1 to 1. If you bought 100K XRP at $.50 and trade them for 100K FXRP when XRP is worth $1, you now have a $50K capital gain.

At the end of the day, no. Not for me at least. But yeah, there's a lot of gray area around these transaction types, which is why I'd planned to handle it as if I were placing the XRP in a collateral pool, then drawing it back upon redemption. But I'm willing to explore other options - though I really don't want to be the first one through the door with the IRS 

It's interesting because, unlike a trade from ETH > BTC, or even USD >USDC, here we have what amounts to swapping one asset for a trustless representation of itself; though they are conceived as two distinctly different assets in order to avoid a custodial relationship with the Flare agent, thus a trade needs to be recorded.

Haven't thought about it too much recently, but am leaning toward treating your XRP >FXRP transaction similar to a token swap as outlined here:

https://www.forbes.com/sites/shehanchandrasekera/2019/12/19/how-cryptocurrency-swaps-are-taxed/?sh=80fb4c66f568

Quote

Although there is no direct tax code governing token swaps, it is reasonable to think that guidance related to stock splits apply to token swaps. According to the IRS, a stock split occurs when a company creates additional shares, thus reducing the price per share.

If you own stock that has split and now own additional shares, you must adjust your basis per share or per the lots of the stock you own. If the old shares of stock and the new shares are uniform and identical, then:

• Allocate the basis of the old shares to the old and new shares
• Determine the per share basis by dividing the adjusted basis of the old stock by the number of shares of old and new stock

Thus, stock splits are not taxable events. However, they do affect cost basis for a shareholder. Applying this logic to token swaps, new coins resulting from token swaps do not create a taxable event. However, it is crucial that you allocate the basis among the new coins and start tracking them properly. Figuring out the cost basis and distributing them among the new coins can be tricky after you go through a coin swap.

I mean, there must be some way to record this as a trade without realizing capital gain or loss - this is grossly out of line with the spirit of the nature of the transaction. 

In the earlier trade of USD >USDC that I mention, a 1:1 peg is guaranteed on the exchange where the purchase is made (Coinbase), and let's presume the cost basis for either asset was known to be $1 - this can be recorded as a simple trade, without showing any capital gain or loss, and so cost-basis isn't an issue. But the idea is to record the transaction so as to preserve cost basis going forward, not so much out of the concern for tracking the taxes you'll owe on it. 

But if I bought 100K XRP at $.50 in 2018 and want to trade it for 100K FXRP in 2021 when XRP is worth $1 - it's not just that XRP is now worth $1; it's that FXRP is also worth $1 ... per the FXRP documentation, I feel confident enough in filing my taxes as though a 1:1 peg to XRP is said to exist:

 https://flare.xyz/app/uploads/2020/08/FXRP_Version_1.0.pdf

Quote

2.1 FXRP - a trustless representation

In order to create a representation of XRP on Flare in a trustless and decentralized manner, we first make the assumption that the loss of a unit of XRP to a designated beneficiary can be fully rectified by awarding said beneficiary an alternative asset that allows them to replace the lost unit of XRP with no additional financial burden. This assumption allows us to specify the creation of an asset on Flare called FXRP which is convertible for XRP and collateralized by Flare’s native token, the Spark

I would've bought the 100K XRP before the asset FXRP ever existed - and when I bought them, the price was $.50 .... given that FXRP inherently endeavors to mirror the value of XRP, it would seem that when I purchased the XRP shouldn't matter, because the price of FXRP would've theoretically been the same if it had existed; therefore cost basis should be presumed to be the same. This is more in the spirit of the nature of the transaction, and what I'd have my accountant present as an argument to the IRS.

But feel free ... you first! 

Well, to that end, with the software I use to track my transactions, I'd need to create a new asset 'FXRP' and peg it's price to XRP. I might have to figure out a workaround because the software won't automatically allow me to peg an asset to XRP, only BTC and ETH.  But I'd want to show that FXRP always had the same historical price of XRP - then it should record as a trade for two different assets that have/have always had the same price.

This is how I've handled XRPL transactions: traded XRP for Bitstamp|BTC IOU in 2019, then in 2021 decided to redeem the Bitstamp|BTC IOU for BTC on Bitstamp - I could've just recorded the transaction as if I were dealing in BTC the whole time, but it's not Bitcoin. So I created an asset pegged to BTC - 'Bitstamp|BTC IOU'(because OCD ) and, although there are more line item transactions involved than I'd like, the numbers work out 

[brianwalden]

2 hours ago, CountZerpula said:

At the end of the day, no. Not for me at least. But yeah, there's a lot of gray area around these transaction types, which is why I'd planned to handle it as if I were placing the XRP in a collateral pool, then drawing it back upon redemption. But I'm willing to explore other options - though I really don't want to be the first one through the door with the IRS 

It's interesting because, unlike a trade from ETH > BTC, or even USD >USDC, here we have what amounts to swapping one asset for a trustless representation of itself; though they are conceived as two distinctly different assets in order to avoid a custodial relationship with the Flare agent, thus a trade needs to be recorded.

Haven't thought about it too much recently, but am leaning toward treating your XRP >FXRP transaction similar to a token swap as outlined here:

https://www.forbes.com/sites/shehanchandrasekera/2019/12/19/how-cryptocurrency-swaps-are-taxed/?sh=80fb4c66f568

I mean, there must be some way to record this as a trade without realizing capital gain or loss - this is grossly out of line with the spirit of the nature of the transaction. 

In the earlier trade of USD >USDC that I mention, a 1:1 peg is guaranteed on the exchange where the purchase is made (Coinbase), and let's presume the cost basis for either asset was known to be $1 - this can be recorded as a simple trade, without showing any capital gain or loss, and so cost-basis isn't an issue. But the idea is to record the transaction so as to preserve cost basis going forward, not so much out of the concern for tracking the taxes you'll owe on it. 

But if I bought 100K XRP at $.50 in 2018 and want to trade it for 100K FXRP in 2021 when XRP is worth $1 - it's not just that XRP is now worth $1; it's that FXRP is also worth $1 ... per the FXRP documentation, I feel confident enough in filing my taxes as though a 1:1 peg to XRP is said to exist:

 https://flare.xyz/app/uploads/2020/08/FXRP_Version_1.0.pdf

I would've bought the 100K XRP before the asset FXRP ever existed - and when I bought them, the price was $.50 .... given that FXRP inherently endeavors to mirror the value of XRP, it would seem that when I purchased the XRP shouldn't matter, because the price of FXRP would've theoretically been the same if it had existed; therefore cost basis should be presumed to be the same. This is more in the spirit of the nature of the transaction, and what I'd have my accountant present as an argument to the IRS.

But feel free ... you first! 

Well, to that end, with the software I use to track my transactions, I'd need to create a new asset 'FXRP' and peg it's price to XRP. I might have to figure out a workaround because the software won't automatically allow me to peg an asset to XRP, only BTC and ETH.  But I'd want to show that FXRP always had the same historical price of XRP - then it should record as a trade for two different assets that have/have always had the same price.

This is how I've handled XRPL transactions: traded XRP for Bitstamp|BTC IOU in 2019, then in 2021 decided to redeem the Bitstamp|BTC IOU for BTC on Bitstamp - I could've just recorded the transaction as if I were dealing in BTC the whole time, but it's not Bitcoin. So I created an asset pegged to BTC - 'Bitstamp|BTC IOU'(because OCD ) and, although there are more line item transactions involved than I'd like, the numbers work out 

I disagree. Superman was born on Krypton. He was just an ordinary dude there. He comes to earth and suddenly in this new environment he's got Superpowers. In the way F-assets think of themselves, XRP is Superman on Krypton and FXRP is Superman on earth.

The idea of exchanging one thing for a credit is old and common. You deposit a dollar at a bank in return for a credit at that bank. They're not yet different things, the credit is just a representation of that dollar. Wrapped coins and Ripple IOUs work on the same principle, but instead of individual accounts the deposits are collective. Everyone deposits into the pool of locked assets to get a wrapped coin or IOU representing their ability to redeem that same amount from the pool.

But as much as F-assets may think of themselves as Superman, they are explicitly not implemented that way. In the Flare universe, Kal-El still lives on Krypton while Superman lives on Earth. All Flare does is broker a trade a between the two. They are purposely doing everything they can to avoid a credit/debit system or any type of system where they hold assets in custody.

The way F-assets are implemented they don't end (or suspend) Kal-El's life on the XRPL to exchange him over to a Flare and that implementation is very intentional. And I don't think the IRS is going to let them have it both ways. Flare can't say conceptually that FXRP is just XRP on another planet and also say that FXRP is it's own asset that merely trades at the same price as XRP so that nobody is holding anything in custody.

I'm conclusion, Chewbacca is not an Ewok from Endor. Therefore, you must pay taxes.

[CountZerpula]

To be clear - what you're saying is that the Flare team made it through all rounds of legal consultation and drafting with several tax professionals that weren't competent enough to have pointed this out.  That they are about to go live, and yet - one of the chain's critical core components, being able to mint F-assets, is so poorly executed that it will cause people to incur potentially exorbitant capital gains (or losses) and nobody has noticed until now ... have you reached out to them yet to show them the error of their ways using your Superman analogy?

[brianwalden]

6 hours ago, CountZerpula said:

To be clear - what you're saying is that the Flare team made it through all rounds of legal consultation and drafting with several tax professionals that weren't competent enough to have pointed this out.  That they are about to go live, and yet - one of the chain's critical core components, being able to mint F-assets, is so poorly executed that it will cause people to incur potentially exorbitant capital gains (or losses) and nobody has noticed until now ... have you reached out to them yet to show them the error of their ways using your Superman analogy?

I'm saying they haven't discussed it yet. I'm sure they know what they're doing and already know how they expect them to be taxed, but sometimes in life you have to make tradeoffs. What I'm saying is F-assets are clearly not like wrapped coins. And is clearly not the type of token swap described in that Forbes article. Until I hear from Flare, I'm preparing for the possibility of owing capital gains if I move my XRP over to Flare.

[brianwalden]

Here's another way of thinking about it. The Flare Network sees its F-asset program as a decentralized, cross-ledger exchange where the makers (agents) place bids and asks and the takers (you and me) are only allowed to place market orders. You can throw in the peculiarity that orders are notated as the price set by the FTSO minus a percent fee that the maker takes - but the same thing could be represented by a simple price like in regular order books.

I believe that's pretty close to how Flare would describe it. By building it this way, they deftly navigated a myriad of problems and regulations. But unless there's some other piece of the puzzle (and if there is, I'm sure Flare has found it and is ready to utilize it when F-assets roll out), I think this results in a taxable event.

[CountZerpula]

2 hours ago, brianwalden said:

I'm saying they haven't discussed it yet. I'm sure they know what they're doing and already know how they expect them to be taxed

For my money 'haven't discussed it yet'  doesn't really square with  'know how they expect them to be taxed'.

Section 2.1 of the FXRP whitepaper that I posted above seems very clear, and tells me that they spent some time on this particular issue. The rest of paper is filled with excruciating detail about all of the different processes/mechanics.

2 hours ago, brianwalden said:

What I'm saying is F-assets are clearly not like wrapped coins. And is clearly not the type of token swap described in that Forbes article.

Agreed on both counts in that they are not these things - the question is whether or not a certain tax scenario falls in line with some precedent, enough so to develop a good faith tax strategy in lieu of formal clarity. I wouldn't expect to hear anything more from Flare in the way of tax guidance around F-assets - the FLR distribution mechanics, yes.

1 hour ago, brianwalden said:

I believe that's pretty close to how Flare would describe it.

The only additional commentary I can offer is how they actually did describe it, in all of the documentation and on social media recently

 

It goes deeper and deeper, wades into FATF territory - by that point the entire discussion is overthought for me in terms of immediate tax strategy, but certainly very important topics that we should all be aware of. I'm happy to be corrected and to hear everyone's opinion, and certainly open to change, but my mind is made up for now.

At the end of the day we should all be consulting a tax professional to map out our respective strategies. The method I outlined above is what I'll be doing - recording a trade of underlying asset for F-asset; where both assets share the same price, hence there is no capital gain/loss realized. There are creation/redemption fees associated and tracked accordingly.

Cost basis for the underlying asset is carried forward via the F-asset - you might never actually trade back into the underlying asset - you might trade the F-asset for FLR on FlareFarm, then move that FLR to Bitrue where you sell it for Bitcoin, then plan to sell the Bitcoin into USD on Bitstamp ... you think you're all done with crypto forever until you get wind that Bitcoin is being integrated as an F-asset

And the cycle begins for you again 

[RobertHarpool]

The initial crypto taxation model created by the IRS is clearly not sustainable. It will not work as we walk deeper into the cryptosphere. 

Until there is detailed clarification from the IRS, it will not be so much about a 'right' or 'wrong' approach. It will about whether your returns demonstrate a fair and consistent reporting methodology that is reasonably defensible. 

Tax avoidance and tax evasion are pretty easy for anyone to distinguish. Self-created rules in a vacuum are perfectly fine. It's when they are inconsistently applied or completely ignore precent that you move into the tax evasion zone. 

...this is my understanding of what the IRS expects of tax payers in such situations. 

[CountZerpula]

Well said @RobertHarpool - absent clear guidance, so long as you present a cogent strategy, show that you're acting in good faith and can back up your arguments, and are consistent in your reporting - that's really the best we can do.

It may even be the case that some of the approaches that we put forward end up shaping the guidance.