“How Bitcoin has become the most recognized cryptocurrency, how it is taxed, and what that means for real estate.”
Bitcoin is the most widely used and recognized cryptocurrency as of the start of 2018. It is becoming more and more common with companies paying their employees in Bitcoins, certain retailers allowing Bitcoin as an acceptable payment, and even homes that are listed as ‘Bitcoin-only’ listings. It is considered a convertible virtual currency because it has an equivalent value in real currency. As Bitcoin becomes more popular, it also increases in value. One question on everyone’s mind: How are Bitcoins taxed? Recently, the Internal Revenue Service (IRS) made clarification to the tax treatment of Bitcoin and Bitcoin transactions.
IRS rules that Bitcoins are ‘treated as property’ and not as currency
Bitcoin and other virtual currencies are treated as property for tax purposes, which means that there is capital gain or loss when disposing of virtual currency. If someone is paid in virtual currency, their income is still taxable. Business transactions in Bitcoin are subject to all the normal rules for sales tax. When someone spends virtual currency, they are really performing two transactions in one. They must dispose of the virtual currency and spend the dollar equivalent amount.
Virtual Currency Treatment, from a Tax Perspective
Since Bitcoin must be treated as property, the IRS has stated that, “General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.” On a tax return, “transactions using virtual currency must be reported in U.S. dollars.” “If virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of virtual currency is determined by converting the virtual currency into U.S. dollars…at the exchange rate, in a reasonable manner that is consistently applied.” With these tight tax laws and restrictions on virtual currency, it makes investing in Bitcoin a bit more complex. It also means capitals gains when Bitcoins are disposed of.
Calculating your gain/loss with every Bitcoin Transaction
Since Bitcoins are treated as property, what happens when a property is disposed of? We would follow the same four rules that apply to dispositions of property:
- Income is realized from any gains on the property.
- Gain is measured by the change in the dollar value between the cost basis (the purchase price) and the gross proceeds received from the disposition (the selling price).
- The tax rates that apply depend on whether the property was held for a short-term or for a long-term duration.
- Dispositions of property are reported on the tax return using Schedule D & Form 8949 or Form 4797. These forms require us to "show our math" when calculating a gain or loss.
Tax Tips for Bitcoin Enthusiasts
These are a few tips and tricks when it comes to how Bitcoins are taxed. There are tips for merchants and businesses and the ‘casual Bitcoin user’.
- Identify an exchange rate to use consistently in valuing Bitcoins received.
- Charge sales tax when a customer buys from you using Bitcoin.
- If paying employees in Bitcoin, first withhold all applicable payroll taxes in US dollars. Net pay can then be paid out in Bitcoin as appropriate.
- Taxes are paid in dollars, not in Bitcoin. Consider converting Bitcoins to dollars on a regular schedule so that you have enough dollars to remit any income tax, withholding, or sales tax.
- When paying an independent contractor $600 or more during the year, request Form W-9 and issue Form 1099-MISC, even if you pay them in Bitcoin. Track the amount paid to contractors throughout the year to measure whether you reach the $600 threshold.
- Backup withholding may be required.
- Include Bitcoin transactions when figuring out your estimated tax payments.
- Sales revenue is recorded as business income in dollars.
- Expenses are also recorded in dollars.
- Gain or loss on holding Bitcoin are recorded as trading gains (Form 4797 or Schedule D as appropriate).
Tips for ‘Casual Bitcoin Users’
- Establish a record-keeping system.
- Keep track of when you acquire and when you sell Bitcoins.
- Record dispositions of Bitcoins on Schedule D and Form 8949.
- Each purchase using Bitcoin is two transactions in one: an implied disposition and an expense.
To Sum It Up
Jeremy Naylor, a tax attorney and partner at Cooley, said, "If you hold Bitcoin or ethereum or one of these other convertible digital currencies as a capital asset, when you use that Bitcoin to purchase goods or services — so for example, if I were to take $1 million in Bitcoin to buy an apartment building or something — to the extent that Bitcoin has appreciated since I acquired it, any of that gain, that built-in gain, would be taxed when I used the Bitcoin to buy the building.” The world is changing and there are new ways to purchase goods and acquire wealth. Cryptocurrency has made an everlasting impact on the world’s economy. The question is, are you going to invest?