Thursday, December 4, 2014

IRS Approach To Taxation of Bitcoin

Josh Ungerman for Forbes writes: The IRS approach to the taxation of crypto currencies like Bitcoin may turn into an accounting nightmare for all but the most casual of users.
Virtual currencies, such as Bitcoin, are becoming useful tools in the digital age. In essence, a virtual currency is a currency that exists only in cyberspace and is not backed by any government.  The value often fluctuates by the hour and there is no coin or certificate to touch.
When examining the IRS approach to the taxation of such currencies, the most basic question is whether they will be treated as currency or property. The IRS chose to treat virtual currency as property and opened the door for some detailed and voluminous accounting.  Details of the IRS taxation scheme for the taxation of virtual currencies can be found in IRS Notice 2014-21 [http://www.irs.gov/uac/Newsroom/IRS-Virtual-Currency-Guidance].
Since virtual currencies are treated as property for federal income tax purposes, a good way to view them is to consider how bartering is taxed. When you work on a project and are paid with a truck as a barter, the value of the truck is compensation for services, which constitutes income.  The amount recognized in income becomes the basis in the truck. The subsequent barter of the truck for something else, say, a hot tub, is a realized taxable transaction.  That is, the basis of the Bitcoin transferred to acquire the truck is compared to the value of the asset to which it is exchanged (the hot tub); any value increase is treated as as income.
Given the IRS treatment of virtual currency as property in IRS Notice 2014-21, the burning question will be how a taxpayer will maintain adequate records to determine the correct amount of tax.  Imagine having a cyber-wallet with Bitcoins from numerous transactions that presumably will all have a different basis, especially in light of the fluctuations in value experienced in Bitcoins.  Accordingly, the amount of basis in each Bitcoin will vary widely. Will a taxpayer be able to specifically identify the Bitcoin they are using for basis purposes or will FIFO, LIFO or another method be employed to correctly reflect basis? [snip]/ The article continues @ Forbes, click here to continue reading....

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