IRS: Bitcoin is Property, Not Currency

Today, the Internal Revenue Service ("IRS") issued Notice 2014-21 regarding some federal tax prinicples associated with transactions utlizing virtual currency, such as Bitcoin.

Among other things, this means that if a person purchases a product or services with Bitcoin, they will need to recognize any gain or loss associated with the transaction. For example, if a person purchases a $10 product with Bitcoin, which they pruchased for $5 dollars, that person will need to recognize a gain of $5 dollars associated with the transaction.

In addition to taxes associated with transactions involving Bitcoin, the IRS Notice means that people who choose to trade, buy, sell, or othewise use Bitcoin, will need to keep extensive records as to the date, time, and fair market value of Bitcoin at the time of a transaction. 

Fair Market Value ... In U.S. Dollars

In the United States, the fair market value of Bitcoin for tax federal purposes is, as might be expected, determined with reference to the U.S. Dollar, according to the IRS:

Q-3: Must a taxpayer who receives virtual currency as payment for goods or services include in computing gross income the fair market value of the virtual currency?

A-3: Yes. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, 2  measured in U.S. dollars, as of the date that the virtual currency was received. See Publication 525, Taxable and Nontaxable Income, for more information on miscellaneous income from exchanges involving property or services.

Q-4: What is the basis of virtual currency received as payment for goods or services in Q&A-3?

A-4: The basis of virtual currency that a taxpayer receives as payment for goods or services in Q&A-3 is the fair market value of the virtual currency in U.S. dollars as of the date of receipt. See Publication 551, Basis of Assets, for more information on the computation of basis when property is received for goods or services.

Q-5: How is the fair market value of virtual currency determined?

A-5: For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

While there are many noteworthy implications to today's notice, the IRS' position on recognition of gain when a Bitcoin is "mined", or otherwise comes into existence, is of particular interest:

Q-8: Does a taxpayer who “mines” virtual currency (for example, uses computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger) realize gross income upon receipt of the virtual currency resulting from those activities?

A-8: Yes, when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income. See Publication 525, Taxable and Nontaxable Income, for more information on taxable income.

The means, among other things, that taxpayers who mine Bitcoin are required to recognize gain based upon the fair market value — in U.S. Dollars — at the time the currency is mined, not simply when it is traded, bought, sold, or otherwise used.

This brief overview of some important considerations associated with Bitcoin and virtual currency is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

Steve Cook is an attorney at Cook & Cook. Although his office is located in Mesa, Arizona, he represents clients throughout the Phoenix, Arizona Metropolitan area including the following east valley cities: Scottsdale, Paradise Valley, Tempe, Chandler, & Gilbert.

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