Original Crypto Coin does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult with your own tax, legal, and accounting advisors before engaging in any transaction.
On March 25, 2014, the IRS release Notice 2014-21 IRS Virtual Currency Guidance to describe how existing tax principles apply to virtual currency transactions. Virtual currency is treated as property in the eyes of the IRS. This means sales or exchanges of virtual currency follow the same tax regulations as the sales or exchanges of tangible goods like the sale of a house, or the sale of business products to consumers.
Virtual currency can fall into one of three types of property: business, investment, or personal property. Each type is treated differently for tax purposes and unfortunately the IRS has not released further guidance beyond Notice 2014-21.
Businesses that sell products or services in exchange for virtual currency must include the virtual currency in their gross income. The business must determine the Fair Market Value (FMV) of the currency in US dollars as of the date of the transaction using an online exchange.
Beyond exchanging goods and services for virtual currency, one can also create a business dealing with virtual currency, such as “miners.” Those businesses may be subject to self-employment tax depending on the business entity.
A business making payments using virtual currency have the same reporting requirements as businesses paying in cash or barter. Payments of currency equaling $600 or more in US dollars to independent contractors must file an information return to the IRS. Payments to employees must be reported on a W-2 form and taxes including federal income, Social Security, Medicare, and unemployment must be withheld and remitted to the IRS.
For investment purposes, virtual currency is considered a capital asset and is subject to taxation based on short term or long term holding periods. For currency held less than one year, the transaction is considered short-term and is taxed at ordinary income tax rates. In other words, an individual in the 25% tax bracket would pay the same rate on short-term currency transactions. Currency held for one year or longer is considered long-term and is taxed at the capital gains tax rate. Capital income is taxed at 0%, 15%, or 20%, and is dependent on the taxpayer’s tax bracket.
Like securities and stock sales, virtual currency held for investment can lead to either a taxable gain or a deductible loss. It is important to track the basis for each coin for tax purposes. Basis is the FMV of the coin on the date of purchase. A taxable gain occurs when the FMV of the coin on the date of sale is higher than the basis at the time of purchase. A deductible loss occurs when the FMV of the coin on the date of sale is lower than the basis at the time of purchase. Capital losses more than $3,000 carry forward to future tax years and can offset future capital gains until the capital loss is fully used.
Because basis is used to calculate gains and losses, it is important to track the basis of the currency. As it is difficult to track each coin individually, most Certified Public Accountants, Tax Attorneys, and Enrolled Agents agree that the First-In First-Out (FIFO) method may be used although the IRS has not provided any guidance in this matter.
Like most items owned for personal use, virtual currency is treated as a capital asset. Short-term and long-term holding periods apply. Purchasing or acquiring a coin, then using the coin in every day transactions leading to a capital gain, will be taxed at ordinary income rates. Purchasing or acquiring coin, then holding the coin for a year or more, before using it in a transaction will be taxed at capital gains tax rates. Unlike investment or business use of coins, a personal loss is not deductible.
The IRS may eventually release more updated regulations and guidelines to the taxability of virtual currency, but until then it is important to use the services of a professional tax preparer such as a CPA, Tax Attorney, or EA.
Joe purchases 1 Bitcoin on January 30, 2017 for $917.99. He holds his Bitcoin until December 18, 2017 when he sells the coin for $19,498.63. Because Joe held his coin for less than one year, his gain of $18,580.64 (19,498.63 – 917.99) is taxed at his ordinary tax rate. Since the sale of the coin, Joe is now in the 25% tax bracket, and the gain on the sale is taxed at the same rate.
Sam purchases 1 Bitcoin on December 1, 2016 for $748.29. He holds his Bitcoin until December 18, 2017 when he sells the coin for $19,498.63. Because Sam held his coin for longer than one year, his gain of $18,750.34 (19,498.63 – 748.29) is taxed at the capital gains rate for his tax bracket. Although Sam is also in the 25% tax bracket with the sale of his coin, the capital gains rate for the sale is only 15%.
Emily purchases 2 Bitcoins on July 24, 2016 for $660.53. She sells the two coins on August 4, 2016 to pay for a vacation. Because the sale of the coins is to pay for a personal vacation, the loss of $168.74 (1,152.32 – 1,321.06) is not deductible.