Taxation of Bitcoin and Other Virtual Currency

by Michael on Apr 8, 2014

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As a followup to my recent post about IRA rollover rule changes, I wanted to share another bit of news from the IRS…

In Notice 2014-21, the IRS has declared that Bitcoin and other virtual currencies are to be treated as property for federal tax purposes. This means that such currencies are subject to capital gains taxes.

More specifically:

“Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like ‘real’ currency […] but it does not have legal tender status in any jurisdiction.

[…]

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as ‘convertible’ virtual currency.

[…]

In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability.”

And, finally, from their FAQs:

Q: How is virtual currency treated for federal tax purposes?

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

From an investor’s perspective, the basis of the virtual currency is the fair market value on the date of receipt. And when it comes to exchanging virtual currency for actual dollars, the tax treatment is straightforward…

If you receive more than you paid for it, you have a capital gain. In contrast, if you receive less than you paid for it, you have a capital loss.

Going forward, if the fair market value of goods or services received in return for payment with a virtual currency exceeds your basis, you are liable for a taxable gain. And if you get goods or services worth less than your basis, you’d have a loss.

While this seems (relatively) straightforward, I can envision it getting rather messy for an individual investor. And, as a result, it could represent an substantial impediment to widespread adoption of virtual currency.


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