Are Bitcoins Property or Currency for Tax Purposes? The IRS Rules Explained

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As tax time looms, the IRS has set forth rules about whether they will treat (and so you should treat) Bitcoins and other virtual currency as, well, currency, or property, for tax purposes. The short answer is that the IRS will treat virtual currency such as Bitcoin as property for tax purposes. Here is a more full explanation.

First, in case you need it, here is our explanation of Bitcoins and Bitcoin mining.


 

The IRS recently ruled that it will be treating Bitcoins and other virtual currency as property. As the IRS explains, Bitcoin “does not have legal tender status in any jurisdiction,” and so treating it instead as property makes sense.

This means that if you are holding Bitcoins, an increase in value could be considered as a capital gains increase, and taxed accordingly. It also means a decrease in value can be treated as a loss.

Here is what the IRS has to say about it:

 

IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply

IR-2014-36, March. 25, 2014

WASHINGTON — The Internal Revenue Service today issued a notice providing answers to frequently asked questions (FAQs) on virtual currency, such as bitcoin. These FAQs provide basic information on the U.S. federal tax implications of transactions in, or transactions that use, virtual currency.

In some environments, virtual currency operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.

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The notice provides that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency. Among other things, this means that:

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

Further details, including a set of 16 questions and answers, are in Notice 2014-21, posted today on IRS.gov.

The IRS has also created this helpful Notice and Virtual Currency FAQ, the FAQ portion of which we reprint here:

Q-1: How is virtual currency treated for federal tax purposes?

A-1: For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transacti ons apply to transactions using virtual currency.

Q-2: Is virtual currency treated as currency for purpo ses of determining whether a transaction results in fore ign currency gain or loss under U.S. federal tax laws?

A-2: No. Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.

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 fa ir market value of the virtual currency, 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 taxp ayer 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 mar ket value of virtual currency determined?

A-5: For U.S. tax purposes, transactions usi ng virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be requi red 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 det ermined 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 exchan ge rate, in a reasonable manner that is consistently applied.

Q-6: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

A-6: Yes. If the fair market va lue of property received in exchange for virtual currency exceeds the taxpayer’s adjust ed basis of the virtual curren cy, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. See Publication 544, Sales and Other Dispositions of Assets , for information about the tax tr eatment of sales and exchanges, such as whether a loss is deductible.

Q-7: What type of gain or loss does a taxpayer realiz e on the sale or exchange of virtual currency?

A-7: The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpay er generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realiz es ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held main ly for sale to customers in a trade or business are examples of property that is not a capital asset. See Publication 544 for more information about capital assets and the character of gain or loss.

Q-8: Does a taxpayer who “mines” virt ual 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?

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Are Bitcoins Property or Currency for Tax Purposes?  The IRS Rules Explained

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.

Q-9: Is an individual wh o “mines” virtual currency as a trade or business subject to self-employment tax on the income derived from those activities?

A-9: If a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not underta ken by the taxpayer as an employee, the net earnings from self-employment (generally, gross in come derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self- employment income and are subject to the self-employment tax. See Chapter 10 of Publication 334, Tax Guide for Small Business , for more information on self- employment tax and Publication 535, Business Expenses, for more information on determining whether expenses are from a bu siness activity carried on to make a profit.

Q-10: Does virtual curre ncy received by an inde pendent contractor for performing services constitu te self-employment income?

A-10: Yes. Generally, self-employment income includes all gross income derived by an individual from any trade or business ca rried on by the individual as other than an employee. Consequently, the fa ir market value of virtual currency received for services performed as an independent contra ctor, measured in U.S. do llars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax. See FS-2007-18, April 2007, Business or Hobby? Answer Has Implications for Deductions, for information on determining whether an activity is a business or a hobby.

Q-11: Does virtual currency paid by an employer as remuneration for services constitute wages for em ployment tax purposes?

A-11: Yes. Generally, the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. Consequently, the fa ir market value of virtual currency paid as wages is subject to federal income ta x withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement . See Publication 15 (Circular E), Employer’s Tax Guide , for information on the withholding, depositing, reporting, and paying of employment taxes.

Q-12: Is a payment made using virtua l currency subject to information reporting?

A-12: A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a paym ent of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities, and compensation.

Q-13: Is a person who in the course of a trade or business makes a payment using virtual currency worth $600 or more to an independent contractor for performing services required to file an information return with the IRS?

A-13: Generally, a person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor fo r the performance of services is required to report that payment to the IRS and to the payee on Form 1099- MISC, Miscellaneous Income . Payments of virtual curren cy required to be reported on Form 1099-MISC should be reported using the fair market value of the virtual currency in U.S. dollars as of the date of payment. The payment recipient may have income even if the recipient does not receive a Form 1099-MISC. See the Instructions to Form 1099-MISC and the General Instructions fo r Certain Information Returns for more information. For payments to non-U.S. persons, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities .

Q-14: Are payments made using virtual currency su bject to backup withholding?

A-14: Payments made using virtual currency are subject to backup withholding to the same extent as other payment s made in property. Therefor e, payors making reportable payments using virtual currency must solicit a taxpayer iden tification number (TIN) from the payee. The payor must backup withhold from the payment if a TIN is not obtained prior to payment or if the payor receiv es notification from the IRS that backup withholding is required. See Publication 1281, Backup Withholding for Missing and Incorrect Name/TINs, for more information .

Q-15: Are there IRS information reporti ng requirements for a person who settles payments made in virtual currency on behalf of merchants that accept virtual currency from their customers?

A-15: Yes, if certain requirements are met. In general, a thir d party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third party settl ement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third Party Network Transactions , if, for the calendar year , both (1) the number of transactions settled for the merchant exceeds 200, and (2) the gross amount of payments made to the merchant exceeds $20, 000. When completing Boxes 1, 3, and 5a-1 on the Form 1099-K, transactions where the TPSO settles payments made with virtual currency are aggregated with transacti ons where the TPSO settles payments made with real currency to determine the tota l amounts to be reported in those boxes. When determining whether the tr ansactions are reportable, the value of the virtual currency is the fair market value of the virt ual currency in U.S. dollars on the date of payment. See The Third Party Information Reporting Center, http://www.irs.gov/Tax-Professionals/Third-Party-Reporting-Information-Center , for more information on reporting transactions on Form 1099-K.

Q-16: Will taxpayers be s ubject to penalties for havi ng treated a virtual currency transaction in a manner that is inconsiste nt with this notice prior to March 25, 2014?

A-16: Taxpayers may be subject to penalties fo r failure to comply with tax laws. For example, underpayments attribut able to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In ad dition, failure to timely or correctly report virtual currency transactions w hen required to do so may be subject to information reporting penalties under section 6721 and 6722. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish that t he underpayment or failure to properly file information returns is due to reasonable cause.

  
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Are Bitcoins Property or Currency for Tax Purposes?  The IRS Rules Explained

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