Borderless cybercurrency, meet the U.S. tax code.
With this month’s tax-filing deadline, Bitcoin has reached a milestone in its long-shot quest to become real digital money. The ranks of taxpayers grappling with how to fit their cyberriches into their returns has grown large enough for the federal government to offer the first set of guidelines. And accountants are facing a small but noticeable uptick in questions from clients.
Matthew Whatley, the founder of Tax Ninja, a firm serving the San Francisco startup set, says that he fielded his first Bitcoin-related tax question last year, when about five people said they had profited by speculating on the cybercurrency. This year he has already heard from 50 people.
Given that few people really understand taxes and even fewer understand Bitcoins, it’s tempting to believe that tax issues surrounding the cybercurrency would be mind-blowingly complex. In most cases, Whatley says, things remain fairly simple. The Internal Revenue Service tried to clear things up last week by saying it considered Bitcoin property, not money—and anyone making money from Bitcoins should tell the government about it.
If someone bought a single Bitcoin when it was worth $100 and sold it this week for $465, that would require a report of $365 in capital gains. The tax rates on such gains can be upwards of 40 percent, depending on how long someone held the Bitcoins and their overall income. Like stock gains, Bitcoin gains are taxed only when someone cashes them in.
Whatley had already been advising his clients to consider Bitcoin investments as capital gains. But the IRS has officially eliminated a trick that could have been a potential windfall in a future where major purchases could be made with Bitcoins. “There was this giant awesome loophole that existed,” says Whatley. “If you had a million dollars in Bitcoin that you originally spent a few thousand dollars for, you could buy a house and not pay capital gains taxes on it.”
Bitcoin’s believers are split on whether the IRS’s attention is a good or bad development. On the one hand, it’s another federal agency weighing in on Bitcoins in a not entirely hostile way. On the other hand, the IRS’s proclamation that Bitcoin isn’t currency could be self-fulfilling. Investors can keep track of capital gains with relative ease, but having to account for constant changes in value makes the idea of a day-to-day life full of Bitcoin transactions seem rather daunting.
“I have to question the effectiveness of Bitcoin as a medium of exchange when the user has to calculate his or her tax liability on every single transaction,” wrote a Reddit user claiming to be a tax attorney who has been providing exhaustive answers to tax questions about Bitcoin. “As the saying goes, the power to tax is the power to destroy, and this is no exception.”
Things could get particularly complicated for Bitcoin miners, who create new coins by verifying the transactions of others. People running such operations would have to account for the value of each coin at the moment it came into existence while figuring out exactly how to deduct the electricity costs from running Bitcoin mining rigs, which are power hogs. Everything becomes trickier for other types of cybercurrencies that don’t necessarily have exchanges with agreed-on prices.
Another bitter pill to swallow for people drawn to Bitcoins for matters of discretion is uncertainty around when you have to tell the taxman about your Bitcoin fortune. While the IRS has ruled that Bitcoin can’t be considered foreign currency, accountants offer differing opinions about whether Bitcoin accounts are foreign accounts that must be reported to the government or at what threshold such requirements kick in.
Given the heavy penalties, anyone with more than $10,000 in Bitcoins should tell the federal government, says Dave Baldwin, an accountant who is part of a task force studying virtual currencies for the American Institute of CPAs. ”If it was me, and I was holding Bitcoins, I’d probably do so,” he says. “You can’t afford the cost not to report.”
Then there’s Mt. Gox, the Bitcoin exchange that shut down earlier this year after admitting it had lost almost all its users’ Bitcoins—along with reams of data about past transactions. “I need to know when I purchased my BTC and at what price, but Mt. Gox took that information down with them when they imploded,” wrote Andrew Badr, the organizer of San Francisco’s Bitcoin Meetup. “I unsuccessfully tried to find my records in their database that got leaked by hackers.”
Victims of the Mt. Gox disaster may also have a significant tax benefit: They can write off their losses, offsetting future gains on other investments, Bitcoin-related or otherwise. But if someone bought Bitcoins several years ago, the IRS would view the losses as minimal, because value would be measured by the cost of the acquisition, not the value of the Bitcoins at the time of its disappearance.
Whatley thinks that someone could challenge this, but it will take a while. Mt. Gox collapsed earlier this year, meaning it would be tax day 2015 before someone could try to claim losses. There would likely be several years of back and forth before a ruling was handed down. By that time, many skeptics think the Bitcoin story will be long done.
Count Whatley among them. “I don’t own any Bitcoin,” he says. “And I don’t plan on buying any.”