Many people are somewhat perplexed when they find out that the IRS does not consider Bitcoin to be currency. After all, isn’t Bitcoin a medium of exchange that is typically utilized to buy and sell goods and services? While the use of Bitcoin does often closely mirror the use of cash, credit cards, and other common methods of payment there are important differences that distinguish Bitcoin (and similar forms of electronic currency) from cash and other forms of currency.
For one, while Bitcoin is often used like cash, it is not regulated or otherwise controlled by a national treasury or other governmental or quasi-governmental agency. Furthermore, the supply of currency can typically be manipulated by the Treasury. In Bitcoin, the supply of bitcoins are finite and set according to a predefined algorithm. Finally, unlike cash, Bitcoin is not legal tender. Unfortunately, these differences are rather abstract and it is often difficult for people to conceptualize this difference. The following scenario is mean to highlight how Bitcoin is different from cash and other forms of currency and the tax obligations these differences can create.
Recently a man in California who sought to purchase a home in Bitcoin experienced an unplanned unforeseen windfall due to the nature of Bitcoin. Bitcoin is considered property by the IRS. Due to the still nascent stage of the technology, Bitcoin is subject to significant volatility which can include extreme variations in valuation. Recently, Bitcoin has significantly increased in value.
In a recent interview with Bitcoin Magazine, Bitpay CCO Sonny Singh recounted how his company assisted a man with the purchase of a home through bitcoin. Bitpay was brought into the transaction by a real estate developer who was looking for guidance regarding how to conduct the transaction.
While the exact details regarding the transaction are somewhat sparse, one can assume that the bitcoin was placed in escrow or a similar type of account to help facilitate the purchase. From the time the money was placed in the account to the time the transaction closed, the value of Bitcoin had increased from about $750 to $1,000. Thus, during the course of the transaction, the value of the purchaser’s bitcoin had increased by roughly 25 percent. After the transaction was completed, the increase in value meant that the purchaser was left with a profit of roughly $1.3 million. According to the CCO, the beneficiary of this windfall used the extra money to buy a Lamborghini at a Newport Beach, Orange County car dealership.
While a “free” Lamborghini is certainly an attention grabbing headline, the money made through bitcoin appreciation is not free and clear from taxes. The article fails to make any mention of the tax obligations the individual incurred as part of his or her Bitcoin transaction. While certain tax consequences are inherent in the purchase of a home or other property, for the purposes of this article we will focus only on the capital gains tax obligation incurred through the appreciation of property.
Essentially, all property is subject to capital gain and capital loss tax treatment. That is, if the value of the property increases from the time the individual obtains the property to the time they sell, transfer, or otherwise, dispose of the property then capital gains taxes are due. Conversely, if the value of your Bitcoin has decreased from its base value, then you may be able to take a capital loss against your other income. Generally, capital gain and capital loss are reported on IRS 1040 Schedule D. However, unlike similar reporting requirements for stocks, bonds, and shares holders of Bitcoin will not necessarily have a broker who will supply an easy to follow 1099 detailing capital gain and loss. Thus, the individual taxpayer is typically responsible for recording the property’s original value, transfer value, and any applicable gain or loss. Depending on your method of accounting and patterns regarding acquiring, holding, and transferring Bitcoin computing capital gain and loss can range from a relatively simple and straightforward task to one of immense detail and complexity. A tax professional can help you assess this and all other existing tax obligations.
If you had the foresight to invest in Bitcoin through the purchase of Bitcoin or Bitcoin mining operations, you face a number of existing and emerging tax reporting and payment obligations. Also keep in mind that the actual minining of bitcoin leads to self employment income which is taxed at ordinary (not preferential capital gain rates) and is subect to self employment taxes. The tax lawyers of the Tax Law Offices of David W. Klasing can assist with your Bitcoin and other tax questions. To schedule a confidential reduced rate initial consultation, call 800-681-1295 today.