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Many years ago, I bought around 400 BTC for a few hundred dollars (?) and stored them in a hard drive. Shortly after that, I lost this hard drive, wrote it off as an "Oh well" and didn't think anything more of it.

Last week I found the hard drive and, according to Google, it's worth around 1,000,000 USD.

I know how to sell the btc, I just don't know what will happen to me if I do and what I should prepare myself for legal and tax-wise. I would like that money, but have no idea what kind of tax and legal cataclysm I should expect, as I have no documentation on what I paid for them, or even where they came from. I am in the US, in Michigan.

I really don't know much about bitcoin, so if there is a way to track this stuff down I would be grateful if someone could share it with me.

What steps do I need to take to declare this money and obtain it without getting arrested / investigated?

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+50

The existing IRS guidance in the US related to bitcoin indicates it will be taxed as property.

You'll sell your coins then when you file your taxes for that year you will indicate the dollar value that you sold as a capital gain with a $0 cost basis since you can't prove your initial cost. You can use a block chain explorer to get an idea of when the coins were transferred to your wallet to lay to rest any idea that someone paid you $1,000,000 for some sort of nefarious reason today.

Prepare to be audited, I'd probably shop around for a local tax guy willing to prepare your return. Additionally, I probably wouldn't sell it all at once or even all in a single year.

It's obvious but I think it's worth saying, there's no law against making money. You bought the equivalent of junk a number of years ago that, by some kind of magic, has a value today. You're capitalizing on the value increase. I don't think there's a reason to "worry" about the government.

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    If you use the blockchain explorer @quid mentioned you should be able to prove you got it at some price legitimately – Andrew Diamond Jul 6 '17 at 17:58
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    @SomeGuy, I understand. You only have to prove it's not money laundering if the government decides to ask if it was money laundering. Money laundering comes with a lot of other tell-tale signs like owning a cash business and/or an eerie lack of bank transactions given a person's possessions and you probably don't fall in that bucket naturally. But to reitterate, I wouldn't sell the $1mm at one time. I wouldn't want to be the government's audit test case. – quid Jul 6 '17 at 18:04
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    I doubt he'll get audited. If he pays taxes and line-items the sale, it's pretty clear what happened on the tax return and Uncle Sam will be pleased with the extra taxes. A $1m windfall isn't really all that rare. – Rocky Jul 6 '17 at 18:06
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    It doesn't matter if you doubt he will audited, the idea is to be prepared for one, and only make claims on your tax return that you can prove. – quid Jul 6 '17 at 18:08
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    I think we're in agreement. – Rocky Jul 6 '17 at 18:10
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Document how you came to have the stuff in the first place. First to defend against potential government inquiry; and second to establish that you held the asset more than one year, so you qualify for long-term capital gains rate.

I wouldn't sell it privately all at once, if you can avoid it.

If you can prove you held it more than a year, you should pay the long-term capital gains tax rate, which is fairly low. You'll keep most of it.


Be extremely wary of "the lottery winner's curse"

A huge windfall often goes very badly. People don't change their financial habits, burn through their winnings shockingly fast, overspend it, and wind up deep in debt. At the end of the crazy train, their lives end up worse.

That wasn't your question, but you'll do better if you're on guard for that, with good planning and a desire to invest it in things which give you deferred income in the future. That's the cooler thing, when your investments mean you don't have to go to work!

Not for everyone: Donate to charity!

I don't mean donate ALL of it to charity. But feel free.

If you hold a security more than one year, and donate it to charity, you get a tax deduction for the appreciated value (even though the security didn't actually cost you that). (link) Do not convert the BTC to cash then donate the cash. Donate it as BTC.

Your tax deduction works against your highest tax bracket. If you are paying in a 28% tax bracket (your next $100 of income has $28 tax), then for every $100 of charitable donation, you get $28 back on Federal. It does the same to state tax, and you also avoid the 10-15% capital gains tax because you didn't sell the securities. Do your 1040 both ways and note the difference.*****

Your charitable deduction of appreciated securities is capped at 30% of AGI. Any excess will carryover and becomes a tax deduction for the next year, and it can carryover for several years. **

Use a donor-advised fund.

If you have are donating more than $5000, you don't need to search for a charity that will take Bitcoin, and you also don't need to pick a charity now. Instead, open a special type of giving account called a Donor-Advised Fund. The DAF, itself, is a charity. It specializes in accepting complex donations and liquidating them into cash. The cash credits to your giving account. You take the tax deduction in the year you give to the DAF. Then, when you want to give to a charity, you tell the DAF to donate on your behalf***.

You can tell them to give on your behalf anonymously, or merely conceal your address so you don't get the endless charity junk mail. The DAF lets you hold the money in index funds, so your "charity nest egg" can grow with the market. Mine has more than doubled thanks to the market. This money is no longer yours at this point; you can't give it back to yourself, only to licensed charities.

The Fidelity Donor Advised Fund makes a big thing of taking Bitcoin, and I really like them. ****

I love my DAF, and it has been a charitable-giving workhorse. It turns you into a philanthropist, and that changes you life in ways I cannot describe. Certainly makes me more level-headed about money. Lottery winner syndrome is just not a risk for me (partly because I'm now on the board of charities, and oversee an endowment.)

Donating generally will reduce suspicion (criminals don't do that), but donating to a DAF even moreso. Since the DAF would have to return ill-gotten gains, they're involved. Their lawyers will back you up. The prosecutor is up against a billion dollar corporation instead of just you. With Fidelity particularly, Bitcoin is a crusade for them, and their lawyers know how to defend Bitcoin. A Fidelity DAF is a good play for that reason alone IMO.


** The gory details: Presumably you are donating to regular charities or a Donor Advised Fund, and these are "50% limit organizations". Since it's capital gains, you have a 30% limit. If your donation is more than 30% of AGI, or if you have carryover from last year, you use Worksheet 2 in Publication 526. You plug your donations into line 4, then the worksheet grinds through all the math and shows what part you deduct this year and what part you carryover to the next year.

*** I specifically asked managers at two DAFs whether they were OK with someone donating a complex asset to the DAF, and immediately giving the entire cash amount to a charity. The DAF doesn't get any fees if you do that. They said not only are they OK with it, most of their donors do exactly that and most DAF accounts are empty. They make it on the 0.6% a year custodial fee on the other accounts, and charitable giving to them.

Mind you, you can only donate to 501C3 type charities, what IRS calls "50% limit organizations". This actually protects you from donating to organizations who lie about their status.

**** I'm not with Fidelity, but I am a satisfied DAF customer. The DAF funds its overhead by deducting 0.6% per year from your giving account. If you invest the funds in a mutual fund within the DAF, that investment pays the 0.08% to 1.5% expense ratio of the fund. I can live with that.

***** I just Excel'd the value of donating $100 of appreciated security instead of taking it as capital gains income. 28% Fed tax, 15% Fed cap gains, 8% state tax on both. Take the $100 as income, pay $23 in cap gains tax. Donate $100 in securities, the $23 tax goes away since you didn't sell it. Really. The $100 charitable deduction offsets $100 in income, also saving you $36 in regular income tax. Net tax savings $59. However you lost the $100! So you are net $41 poorer. It costs you $41 to donate $100 to charity. This gets better in higher brackets.

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    -1 for "donate it to charity". Yeah, right, you do that when you find $1M sitting under your bed. – Mehrdad Jul 7 '17 at 9:43
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    @Mehrdad Pardon me, I didn't mean "donate all of it." And yes, as a matter of fact, I have done that. That's how I know how the contribution limits work. – Harper Jul 7 '17 at 13:25
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    @WGroleau Sorry I misled you with the 401K analogy, and I edited to remove it. It's not a 401K, it's a charity giving fund. You donate and that is irrevocable, you get the charitable deduction in that year (and if you cap out you can carry it to next year), and you later use the money to donate to charity as you wish. It's a really cool way to get involved in philanthropy, which then becomes a lifetime pursuit. I am now on the board of 2 charities. Your situation is unique because you won't have a problem with that $5000 initial contribution to get a DAF. – Harper Jul 7 '17 at 13:35
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    @schizoid04 because donor advised funds are a powerful way to get into philanthropy, but have an annoying $5000 buy-in. He has a unique situation that makes the initial buy-in easy for him. The explanation is complex because DAFs are. While the tax benefits are better than you say, the bigger benefit is it tends to gateway you into a lifetime love of philanthropy, which changes how you think about money. I find myself tongue-tied at trying to explain why philanthropy is beneficial to a person generally, but it's the best ward I can think of for the lottery winner's curse. – Harper Jul 7 '17 at 14:21
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    @schizoid04 Oh that's easy. Donating to charity is a veritable "get out of jail free" card. First, criminals don't do that. Second, it brings the DAF's lawyers into your case, turning it into a fight between a prosecutor and a billion dollar corporation instead of just you. Fidelity DAF is closely tied to Fidelity, same legal team, and Fidelity is huge into bitcoin, so their lawyers know the landscape. – Harper Jul 7 '17 at 14:31
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In 2014 the IRS announced that it published guidance in Notice 2014-21. In that notice, the answer to the first question describes the general tax treatment of virtual currency:

For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.

As it's property like any other, capital gains if and when you sell are taxed. But there's nothing illegal or nefarious about it, and while you might get some odd questions if a large deposit ends up in your bank account, as long as you answer them there really isn't a problem.

If you don't have documentation of how much you paid for it, if it's a trivial amount compared to what it's worth now you can just declare $0 as your basis. I would suggest you try to have documentation that you've held it at least one year so that it's a long-term capital gain, but you can just mark the purchase date as "Various" on your tax form. I've done this (for a much smaller amount of bitcoins, alas) and haven't run into any trouble.

While there are some good reasons to sell slowly, as others are saying, I want to play devil's advocate for a minute and give you a reason to sell quickly: A decision to hold is equivalent to a decision to buy. That is, if a million dollars randomly ended up in your bank account for no reason, you probably wouldn't choose to go put it all into bitcoin, and then slowly sell it. Yet that's more-or-less an equivalent financial situation to holding on to the bitcoin and slowly selling it. While there are certainly tax advantages to selling over the course of many years, bitcoin is one of the most volatile commodities out there, and one has no idea what will happen over the next few weeks, let alone the next few years. It may go to tens of thousands of dollars a coin, or it may go to basically zero. If I had a million dollars in my pocket, bitcoin isn't how I'd choose to store it all. Just something to think about; obviously you need to make the best choice for you for yourself.

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    "A decision to hold is equivalent to a decision to buy." +1 for this great insight put simply – TheCatWhisperer Oct 18 '17 at 16:48
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1) Document that you held the bitcoins for more than one year. This should not be particularly difficult. Since you haven't moved the bitcoins, you hold the key to an address that has held them for more than one year. While this isn't absolute proof, it should be sufficient.

2) Since you can't document how you bought them easily, you can just assume a tax basis of zero. This will mean you will pay microscopically more in taxes, but don't worry about it.

3) Sign up with an exchange that can handle your sales. Coinbase will work if you want to sell it slowly. Gemini will work if you want to sell more quickly.

4) Get a decent, secure bitcoin wallet. Transfer the bitcoins to the exchange only as you're selling them. Make you first sale fairly small just in case something goes wrong.

5) Keep meticulous notes about each sale -- the date of the sale, the number of bitcoins you sold, and the number of dollars you got.

6) Make sure to keep enough money for taxes. In Michigan, 24.3% would be the highest possible tax rate you might have to pay if you sold a lot or had high income otherwise.

7) Either get a professional to file your taxes for you or learn how to correctly report long-term capital gains. You must report each individual sale.

You may get audited or investigated, but there's nothing to find. The bitcoins have been in stasis for a long time, and it's completely plausible that you bought them and held them. If you can find any proof you bought them (such as a transfer to an exchange) that would be great, but it's not essential. Many people have this same story and unless you're connected to something illegal, you probably don't have anything to worry about.

Congratulations!

So thats my question, what steps do I need to take to declare this money and obtain it without getting arrested / investigated?

There's nothing special you need to do other than keep very good documentation. When you file your taxes, you will need to declare each sale.

(This answer assumes that you didn't have a lot of income last year and significantly less income this year. If that's the case, you may have to pay estimated taxes to avoid a penalty. But that penalty is very small and will be calculated by the IRS for you automatically. So I wouldn't worry about it.)

You may wish to read up on gift taxes to understand how they work. You won't owe any, but you may need to file paperwork with the IRS if you give large gifts (over $14,000) to people and you will use up some of your lifetime exemption. Keep records of any gifts you give.

  • If he knows an approximate (or exact) date he made the purchase, wouldn't it be simple to determine what BC was selling for at that time? – Kevin Fegan Jul 9 '17 at 3:46
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    @KevinFegan Yeah, and if he drops the price a little to be safe, he could use that as his basis. But the difference is so small, and a zero basis is 100% safe. But sure, you could do that. – David Schwartz Jul 10 '17 at 0:51
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Hire an accountant.

Now that you're a millionaire, you're going to want to get a professional to do your taxes for you, because you have more to lose if you mess it up.

If you're lucky the accountant might even give you better financial advice than you'll get from random strangers on the Internet.

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    A competent professional. A CPA once quoted $250 to do my taxes, but after I had to teach him how to do a bad debt deduction … – WGroleau Jul 7 '17 at 12:35
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    I wouldn't ever advise anyone not to hire a professional, but a random CPA may or may not know anything about this particular circumstance. On the other hand, lots of random strangers on the Internet have faced precisely this same issue and some of them have access to very high quality legal representation. The trick is figuring out which they are. – David Schwartz Jul 7 '17 at 20:00
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    @David Schwartz also, if you have an idea of what to expect it can help you evaluate the competence of your professional. – stannius Jul 9 '17 at 14:51
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    Or better yet, a tax accountant. – Pocketsand Jul 12 '17 at 13:53
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Any profits you realize are considered a long term capital gain by the IRS since you have held the asset for longer than a year.

The IRS guidance on virtual currency considers bitcoins to be a form of personal property.

Gains from selling bitcoins are considered a capital gain. See the IRS guidance on reporting capital gains (Schedule D).

protected by Community Jul 9 '17 at 6:58

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