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Monday, June 23, 2014

Bitcoin Taxation - Clarity and Mystery

GAO, Virtual Economies and Currencies (May 2013)
In March 2014, the IRS finally released important guidance on taxation of virtual currency, such as Bitcoin. The key point made in the guidance (Notice 2014-21) is that such currency should be treated as property rather than a foreign currency. That is helpful.  I blogged on that earlier (3/29/14) and I've got a short article in the AICPA Tax Insider (6/12/14) - Bitcoin taxation: Clarity and mystery.  In the article, I note the importance of these issues.  If you are a tax practitioner and don't think you need to deal with it, I'd be surprised if none of your clients uses bitcoin. In fact, a new standard question to ask of people you prepare returns for needs to be: Do you own or use a virtual currency, such as Bitcoin?   There are also a lot of dollars going into Bitcoin and other virtual currency start-ups - one could be your client.

There are still some significant issues for the IRS to address. I note several in the article.  A key one is how to track the use of the virtual currency so you can calculate the gain or loss and whether short-term or long-term, every time it is used. The IRS regulations on basis (section 1012) suggest use of FIFO, but that rule only addresses securities. Thus, the default is specific identification.  Does this mean you'd have to truly identify the bitcoin you used (if feasible - and that may depend on how you hold the bitcoin) or can you just identify on your own which bitcoin you think you used (and that would really need to be done at the time used, rather than when later filing your return).

Please see the article for other issues and activities. I've also got a webpage with links to tax and other information about virtual currency (including some primers on how these crypto-currencies work).

There are also some state tax issues (I'll have more on that later). In June 2014, the California Board of Equalization issued a notice to help retailers who use a virtual currency. There are state income tax questions about sourcing.

What do you think about the tax issues?


Peter Rudolph CPA said...

Would first consider it a currency nice information that it is property. Would you say it is §1245 Property?

Professor Nellen said...

Peter, good question about whether virtual currency is Section 1245 property. Section 1245 property must be depreciable (or amortizable). Such property must also be used in a trade or business (such as manufacturing equipment or a patent) or held for the production of income (such as rental property). Arguably, virtual currency can be "used in" a trade or business such as where it is part of the business model (but it can't be inventory). In Selig, TC Memo 1995-519, the court, referring to the Simon case (2nd Cir. 1995), the taxpayer must show that the property used in the business or held for investment is "subject to exhaustion, wear and tear, or obsolescence." A virtual currency won't fall into that category.