In April 2014, the IRS declared that Bitcoin was property and not currency and would therefore be subject to the capital gains tax or capital loss deduction. But now may be a good time to examine Internal Revenue Bulletin 2014-16 in depth, given the recent uptick in Bitcoin prices (and that’s putting it mildly), along with predictions that the August 2017 price surge may be just the beginning. In fact, one analyst predicted that Bitcoin could be trading at $100,000 per item by 2027. For those of us keeping score at home, that level would be about a 3,400 percent increase over its current record high.
The property designation is a good news-bad news thing for investors. Capital gain tax rates are usually significantly lower than income tac rates, but losses are capped at $3,000 per year, and the cap has not moved since 1978. So, if investors jump on the Bitcoin bandwagon and the market suddenly goes stagnant, depressed investors could be carrying over those losses for many years to come.
Establishing a Baseline Value
Gold is gold and dollars are dollars, in that these items have easily ascertainable fair market values. But cryptocurrency, by its very nature, has no such uniform baseline. Individual exchanges usually price Bitcoin, resulting in a value that varies by as much as 50 percent between different exchanges, sometimes even on the same day.
Bitstamp, Coinbase, and other third-party exchanges have made the calculation easier, but if no such exchange was available or if the investor bypassed this method for whatever reason, things get a little murkier.
In these kinds of cases, the IRS only requires that the taxpayer consistently applies a uniform method. In other words, the best practice is to pick one exchange and stick with it, even if another exchange reference would yield better results on a different day. Auditors usually wind up looking at cherry-picked returns, and that’s attention you do not want.
Cost Basis Methodology
As a brief refresher, investors may generally sell their assets on a LIFO (last in, first out) basis, FIFO (first in, first out) basis, or via specific tax lots like the ones used for stocks. In an environment that features rapidly rising, or rapidly falling, prices, basis makes a big difference.
Assume a taxpayer bought 100 Bitcoin shares in October 2012 when prices were low and another 100 shares in November 2013 when prices faltered a bit, so he has a massive capital gain on the first transaction and a loss on the second one. If he sold assets from the first lot (FIFO), he’d probably maximize his capital gains taxes; if he sold from the second lot (LIFO), he’d report a lower gain.
Many trading platforms make these calculations automatically, so they taxpayer has little or no input into the cost basis method.
Bitcoins and Gifts
Typically, donees inherit the basis of the donors, so if the Bitcoin shares had increased $1,000 when you found them in your stocking, you must report a $1,000 capital gain. Bear in mind that there is a difference between “tips” and “gifts.”
In terms of charitable donations, since Bitcoin is property like bonds or land, donors who give Bitcoin to their favorite charities could be in line for substantial tax savings if they give shares that are more than a year old. If the charity does not have a Bitcoin wallet, many payment processors will establish such accounts for certain 501(c)(3) organizations.
As Bitcoin prices continue to rise, so does government interest in these transactions, as evidenced by the Coinstar affair. So, it’s best to consult with an experienced professional about any questions you have, because IRS agents will almost certainly have some questions of their own. A good person to consult with is a tax attorney as they are the most knowledgeable when it comes to anything pertaining to tax laws.