Virtual Currency Tax Issues

In spring 2014, the IRS issued initial guidance on the tax treatment of virtual currency, from mining to using it. This was Notice 2014-21. The IRS said to treat convertible virtual currency as property. Thus, for example, if I use virtual currency X with a basis of $5 (because I obtained it a while back for $5), to buy a jacket today that is selling for $100, I have a $95 gain on the use of my virtual currency. To know if it is a capital gain or ordinay income, I apply the normal property.  If  I'm holding this virtual currency for investment or personal use, it is a capital asset. If I've owned it longer than one year, I have a $95 long-term capital gain.  I also have a bit of recordkeeping to handle.

Also, before I leave that example, if I instead had a $95 loss, one issue is whether the virtual currency is an investment asset (loss is a usable capital loss) or personal use one (I can ever use the loss). This isn't really one for the IRS. The answer exists today with all types of assets, such as what one might call their art collection (investment or personal use asset?).

The AICPA recently sent a comment letter to IRS listing and explaining ten areas where additional guidance is needed (I was involved in the drafting).  I think these are ten issues that could easily come up in preparation of a return and IRS examination of a return.  I encourage you to take a look at the letter for all ten of the topics.  I'll just note two.

1. Is it permissible to get like-kind exchange treatment if, for example, bitcoin is exchanged for litecoin?  I think the answer is yes, assuming the currency is held for business or investment use. Arguably, the currencies are similar in technology and usage.  We asked the IRS to clarify this topic and to note any factors they would consider pertinent in identifying if currencies are like kind.

2. How is virtual currency held by a merchant for paying bills and having transactions with customers treated?  Is it considered inventory? Is the barter treatment of virtual currency mean that the merchant is also selling the virtual currency (in addition to its goods and services)?  Is this property used in the trade or business with a life longer than one year? (if yes, it would be depreciable which seems odd).

The IRS has a lot of projects on their agenda. Hopefully additional guidance on virtual currency will be one of them.

What do you think?

For more on virtual currency, please check out my website on Virtual Currency and Blockchain Tech.