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How Would a U.S. Bitcoin Transaction be Taxed?

Accepting-bitcoinsOverstock.com, the Sacramento Kings and a few countries have all taken positions on what they will do with Bitcoins.  The two major Bitcoin positions are treatment of it as property, as Singapore has recently adopted, or as currency, as Germany has chosen.  

Much has been written on the creation of the Bitcoin, and its rise in popularity – and value – from 5 cents in 2010 to over $1,200 in 2013.  Bitcoins were born from combining electronic commerce and communications with mathematics, cryptography and privacy – as they only exist when your computer is functioning (or your iPad, smartphone, tablet, smart watch or Google glasses!), and they have no intrinsic value, save for what value people are willing to give.

Although the coins have the characteristics of a geeky board game currency and no country backs their value, they are being used worldwide as if they are real.  And until people and companies decide these Bitcoins have no value, they are essentially “real,” at least until another mathematician comes out with a new version of a virtual currency that devalues the Bitcoin through its popularity.

Is there a tax when using Bitcoins?  When a Bitcoin is used to purchase a product or service, there is an exchange resulting in an agreed upon value for the coin.  For the party using the Bitcoin, there is likely a gain or loss on the use of the coin, since it probably had a different value (basis) than when it was acquired.  The taxation will be determined by the character of the Bitcoin in the transaction – is it considered property or currency?  This is the primary question for the IRS and U.S. Treasury.  Some in the digital currency community are pushing for treatment as property.

Under either scenario, here is my take for how it could work in the U.S.: 

  • Bitcoins treated as property:  As a type of investment or commodity, Bitcoin gains and losses would likely be taxed as capital gains.  For individuals using the coins for non-business purposes, transaction gains would be taxable, but losses would likely be non-deductible.  If it can be established the coins were held as [an investment, there may be support for capital loss treatment.  For business transactions, capital gains and losses would be taxed using the existing tax regulations for the specific entity type.
  • Bitcoins as currency:  For businesses using Bitcoins, taxation would likely be treated similarly to existing rules for foreign currency under IRC section 988 – as ordinary income or loss on the exchange of the coin for value.  However, section 988(e) requires that this treatment not apply to non-business transactions.  Tax law then reverts to pre-1986 law, with a modification added for de minimis personal transactions:  gains less than $200 are not taxed to the individual, measured on a per transaction basis.  And, as above, non-business losses would be non-deductible.

The IRS has not yet addressed the taxation and reporting requirements of “digital” or “crypto“ currency transactions such as Bitcoins.  The U.S. Government Accountability Office reported to Congress last year on the revenue and taxation issues that these currencies pose on the U.S. economy.  Its report concluded with a recommendation that the IRS should issue informal guidance, to be followed by substantive analysis and regulations.  The IRS’ response was that it “… will provide information to taxpayers on the basic tax reporting requirements for transactions involving virtual currencies by linking to existing guidance.”  Not much help there.  Translation: refer to your tax adviser. 

David Baldwin, CPA, Partner, Cleveland Estes Avellone, PLLC. David has been in public accounting for more than 25 years providing tax planning and compliance services, primarily for small to medium-sized businesses and high net worth individuals.  Dave currently serves on the AICPA's Individual and Self Employed Tax Technical Resource Panel and is a member of the Arizona Society of CPAs.  He received his BS in Chemical Engineering from the University of Arizona and his MBA from Cal Poly Pomona.

Bitcoin image via Shutterstock

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