Irs Classification of Virtual Currency as Property

IRS Classification of Virtual Currency as Property

Need for IRS Determination

Bitcoins and similar virtual currencies have become popular mainly in the last

year or two, and the prevalence of their use prompted the IRS to come up with a

solution to a problem that was relatively new: how to classify virtual currency for tax

purposes. Essentially, the IRS could determine that such currency would be treated as

a foreign currency being held and traded by Americans and inside the United States or

property, which would effectively make the Bitcoin economy a barter system.

IRS Declaration

In notice 2014-21, the Internal Revenue Service published a declaration making

it clear that Bitcoins and all virtual currencies are going to be treated as property for the

purpose of all taxation.2 “For federal tax purposes, virtual currency is treated as

property. General tax principles applicable to property transactions apply to

transactions using virtual currency.”3 It seems that the IRS reasoned that trading in

Bitcoins is more like the trade of stocks and bonds than the use of international

currency.

Effect of Declaration on the Use and Taxation of Bitcoins

There are a few major taxation ramifications of the IRS statement setting out the

rule that trading in virtual currency should be treated as trading in property.5 These

include the necessity for a basis adjustment and the tax on capital gains, both of which

have certain subrules.

Basis System

Gains and losses from dealings in property are computed using the basis

system. Although there are several rules that affect the computation and adjustment of

one’s basis in property, the very general idea is that we take into account the price paid

for the property as an individual’s basis in that property; we use that number at the time

of the eventual sale of that property to determine whether a gain or a loss has occurred

due to the holding of that property.

The IRS notice states, “If the fair market value of property received in exchange

for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, 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.”7

Capital Gains Tax

The Capital Gains tax is intended to tax the profits made by individuals on certain

property. One of the principles of the tax system is that gains on property are taxable,

but the amount of the capital gains tax that one will pay in the United States is affected

by how long the asset has been held.8 Property such as stocks and bonds - and now

virtual currency - that is held for less than one year, is said to be short-term.9 Short-term