Cryptocurrency, such as Bitcoin, has been gaining popularity for years and is now accepted at many retail establishments. We will refer to cryptocurrency, also known as “virtual currency,” as VC in this article. In addition to using it as payment for goods and services, many people have chosen to invest/speculate in VC. Traded through various exchanges, VC values have fluctuated tremendously over the last several years. Coinbase, Inc., one of the largest such exchanges, has been ordered by the IRS to disclose trading data of more than 14,000 of its customers.
In 2014, the IRS issued a notice outlining its position on tax treatment of VC transactions. As a fundamental principle, the IRS says VC is to be treated as property, not as currency. As a result, VC purchasers must track their basis in VC to calculate a gain or loss when the VC is sold or used. Although the IRS does not indicate a specific method for tracking basis, the most commonly used methods dealing with corporate stock are:
- FIFO (first in, first out)
- LIFO (last-in, first-out
- Specific Identification
Mutual fund owners also may use average cost.
Here is a very basic example of computing a gain/loss while using the FIFO:
A person (“A”) acquires 4 bitcoins for $40,000 in July 2018
A acquires 2 additional bitcoins for $22,000 in October 2018
A sells 6 bitcoins for $72,000 in September 2019
A would report a 2019 long-term capital gain of $8,000 from the first purchase and a 2019 short-term capital gain of $2,000 from the second purchase.
When a person receives VC as payment for (or uses it to acquire) goods or services, complexity results. Income from receiving VC in exchange for goods or services is fair market value (FMV) on the date it was received, and that receipt is treated as a purchase. If the person subsequently exchanges the VC for goods or services, a gain or loss must be recognized on the change in FMV from the deemed acquisition date to the date the VC is used, a deemed sale. VC payments by employers to employees are subject to tax withholdings and payroll taxes, and payments to non-employees are subject to the same 1099 reporting and back-up withholding rules that apply to payments made with US dollars.
As you likely can imagine by now, a person engaged in many VC transactions will need to have an accounting system capable of tracking all the VC transactions.
A few unresolved tax issues regarding VC are:
- Do the Section 1031 like-kind exchange rules apply to VC exchanged for a different kind of VC?
- How do you handle “hard forks,” which is when a VC is split into two or more different VCs?
- How do you account for lost or stolen VC?
- May VC sellers account for gains and losses using FIFO, LIFO, specific identification, or average cost methods?
Please let us know if you wish to discuss the tax consequences of VC transactions.
Joe Daugherty, CPA
Tax Manager
jdaugherty@deandorton.com • 859.425.7477