IRS guidance on bitcoin transactions will chill its use

By Robert A. Green, CPA

The IRS just issued guidance on bitcoin in time for the April 15th tax-filing deadline. Our Dec. 3, 2013 blog Bitcoin is a hot commodity, but is it taxed like commodities, assets, or currencies? was right, bitcoin is property not a currency.

That's good news for taxpayers with huge gains on using, investing or trading in bitcoin, since it's capital gains treatment and if they held it over one year, the lower long-term capital gains tax rate applies.

Conversely, it's bad news for users, investors or traders with large losses, with the recent price of bitcoin dropping significantly. Without currency tax treatment, it's not Section 988 ordinary loss treatment, which is unlimited versus puny capital loss treatment limited to $3,000 per year.

The IRS guidance stresses a point - widely overlooked by many taxpayers - that using bitcoin to make a purchase of an item or service triggers capital gain or loss recognition reflecting appreciation or depreciation of bitcoin. Compare the market price on the date bitcoin is used to make a purchase, versus the market price on the date you acquired that bitcoin used, and the difference is a capital gain or loss on property. Few people or companies have filed Form 1099s on bitcoin transactions, as may be required, and taxpayers will have to scurry around to figure their cost basis and sales proceeds on each purchase where they used bitcoin as a digital currency. See the example of buying a cup of coffee with bitcoin in the Bloomberg article Bitcoin Is Property Not Currency in Tax System, IRS Says. Laura Saunders WSJ article IRS Says Bitcoin Is Property, Not Currency is good too.

Having to report a capital gain or loss on each purchase using bitcoin will have a chilling effect on bitcoin reaching its goal to be a widely-used digital currency. Who wants to spend 30 minutes or more figuring out their capital gain or loss for a simple $3 cup of coffee? And, then perhaps get audited by the IRS over bitcoin tax reporting to boot?

See the IRS Notice 201421