Law Office of Charles W. Cope, PLLC | IRS Provides Guidance on Taxation of Transaction Involving Virtual Currencies
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  • IRS Provides Guidance on Taxation of Transaction Involving Virtual Currencies
    March 2014
    Last year the General Accounting Office of the U.S. government recommending that the IRS provide additional guidance on tax issues raised by the use of virtual currencies in the real economy. On March 25, 2014, the IRS responded to that request with Notice 2014-21, which outlines general tax principles applicable to the taxation of transactions involving virtual currencies.
     
    Definitions
     
    The notice defines two terms “virtual currency” and “convertible virtual currency.” The former is defined as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” The latter is defined as a virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency. The notice also states that in some environments a virtual currency operates like a “real” currency, but it does not have legal tender status in any jurisdiction.
     
    Some key points
     
    The notice includes certain frequently asked questions about the taxation of transactions in a convertible virtual currency. Some of the key points include:
     
    • A convertible virtual currency is treated as property and not as currency that could generate foreign currency gain or loss for U.S. federal income tax purposes.Thus, taxpayers must track their tax basis in the units of virtual currency they own and calculate gain and loss when disposing of units of a virtual currency.
       
    • A taxpayer who receives convertible virtual currency in payments for goods or services must include in income the fair market value of the virtual currency received.
       
    • Assuming the convertible virtual currency is a capital asset in the hands of the taxpayer, gain or loss realized with respect to a convertible virtual currency will be capital gain or loss.This typically will be the case. There are limits on the deduction of capital losses.
       
    • A taxpayer who “mines” a convertible virtual currency, such as a Bitcoin, realizes gross income from that mining activity.This income would be measured on the date the virtual currency is mined.
       
    • A payment made using a convertible virtual currency is subject information reporting to the same extent as any other payment made in property. Thus, information reporting required by for certain payments, e.g., by section 6041, section 6041A, and 6045, and their related penalties apply to transactions in virtual currencies.
       
    • Taxpayers may be subject to penalties for having treated a convertible virtual currency transaction in a manner that is not consistent with Notice 2014-21, prior to March 25, 2014.This signals that the IRS is willing to examine transactions in virtual currencies taking place prior to the notice, not only to tax them, but to impose penalties on the parties who did not properly report those transactions.
       
      Observations
       
      The Notice does not directly discuss the treatment of losses realized with respect to convertible virtual currencies.  This is a significant issue for some taxpayers after the theft of Bitcoins from the Mt. Gox Exchange, which was discovered earlier this year.  Bitcoins are capital assets for most individuals. The treatment of those losses is determined under section 165, and depending upon the facts, section 165(h), which limits certain loses.
    KEYWORD: Currency