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Virtual currency – often referred to as ‘bitcoin” — is a mystery for many people but an everyday currency for others. As virtual currency grows in popularity, questions arise about its taxation. The IRS treats virtual currency as property and not as currency. This means that general tax principles that apply to property transactions apply to transactions using virtual currency.
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account or a store of value. Many types of virtual currencies have been created recently for use in lieu of currency issued by a government to purchase goods and services in the real economy. Bitcoin is one example.
A 2015 federal government report described how virtual currency is generally obtained. An individual can exchange conventional money for virtual currency a fee on an online exchange. An individual can obtain virtual currency in exchange for the sale of goods or services. An individual can also acquire virtual currency by serving as “miner.” This approach requires significant computer’s processing power.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. While virtual currency may operate like “real” money, it does not have legal tender status in the U.S.
In Notice 2014-21, the IRS announced that it will treat virtual currency as property. The IRS explained that transactions using virtual currency must be reported in U.S. dollars for U.S. tax purposes. Taxpayers must determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied, the IRS explained.
More guidance possibly coming
In November 2016, the Treasury Inspector General for Tax Administration (TIGTA) asked the IRS review its approach to virtual currency. The IRS has established a virtual currency task force but TIGTA reported that the IRS could better coordinate some of its intra-agency activities. TIGTA also found that the while employers and businesses are required to report taxable virtual currency transactions, current third-party information reporting documents did not provide the IRS with any means to ascertain whether the taxable transaction amounts being reported were specifically related to virtual currencies.
TIGTA recommended that the IRS provide updated virtual currency guidance. TIGTA also recommended that the IRS revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions. The IRS agreed with the recommendations. The IRS did not identify when more guidance may be issued. Our office will keep you posted of developments.