January 31, 2018 § Leave a comment
There has been one common theme in almost every tax conversation I have had with friends and family over the last couple of months….. Bitcoin.
What is it? How is it valuable? Will I get rich investing in cryptocurrency?
“I don’t know” is a standard response to these questions from most CPAs these days. But as CPAs, we do need to be aware of the taxation issues involved when holding cryptocurrency for investment. We also need to understand the tax impact of business owners accepting virtual currency for payment of goods and services, as well as using virtual currency as payment for business expenditures.
Cryptocurrency, such as Bitcoin, is a type of ‘virtual currency’ based on cryptographic algorithms and block-chain technology. Bitcoins are digitally ‘mined’ by solving very complicated math problems, thereby verifying a public record of transactions for that Bitcoin.
According to IRS Notice 2014-21, “Bitcoin is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Virtual currencies, like Bitcoin, can be used like any other “normal” currency, or treated as an investment instrument, and these different uses can cause different taxable events.
A business owner may accept Bitcoin as payment for goods and services. The business would record ordinary income based on the fair market value (FMV) of the bitcoin at the time it was accepted. This FMV is then treated like any other income and is taxable. As Bitcoins are also treated as an investment instrument, basis and gain/loss impact must also be considered for every bitcoin transaction.
Let’s say the business owner takes the Bitcoin received for payment and uses that bitcoin to pay for business expenditures. The business would record a deductible business expense at the FMV of the Bitcoin, at the time of the transaction. The business would also record gain or loss based on the FMV at the time of the transaction and the basis in the Bitcoin used as payment for expense. Thus, in this scenario, the business owner would have two separate taxable events if they used Bitcoin to pay for business expenditures.
Bitcoin can also be held for investment use by an individual. In this case, the individual would have a taxable event every time they sold Bitcoin on an exchange, or used Bitcoin to pay for personal expenditures. The individual taxpayer would calculate a taxable gain/loss based on the FMV at the time of the transaction less their cost basis in that Bitcoin. (Note any virtual currency received by an individual as compensation for goods or services provided is treated as ordinary income.)
The main thing to remember with personal or business cryptocurrency transactions is that the currency must be “held for investment” to allow a deduction of any potential loss. The gain is always taxable!
(Please note – In the past, some taxpayers have attempted to apply like-kind exchange treatment to certain types of cryptocurrency transactions, in order to delay the recognition of taxable gain. The like-kind exchange provisions of the Internal Revenue Code have been adjusted by recent tax reform, and no longer allow any property, other than real estate property, to be eligible for like-kind exchange tax treatment.)