Saturday, October 11, 2014

The IRS Considers Bitcoin Property, Not Currency: What It Means

Reading through the IRS Guidance on Bitcoin, it states that the IRS considers Bitcoin as personal property. So, if you, for example, buy a car for $1000 and sell it for $3000 after some minor repairs, the value added is considered income by the IRS and is taxable. Similarly, if you buy Bitcoin at $320 and sell it for $340, you pay taxes on the $20 profit.

This is very similar to stocks, with the exception that you buy whole units of stocks, generally. You can take a loss or make a capital gain. The way you track this is by keeping records of how much you paid for the stock and for how much you sold it, typically using a FIFO (First In, First Out) basis. With stocks, you sell whole units as well. Tracking your stocks only gets ornery when you buy a stock on a recurring basis. With stocks, you also add transaction fees and commissions into your cost.

With Bitcoin, accounting is pretty much the same, except that the arithmetic gets complicated because we do not deal with whole units of Bitcoin on the purchase or the sale.

The best way to think of it is that when somebody pays you in Bitcoin, they are paying you with a non-dividend paying stock that you can redeem somewhere else. Between receiving the Bitcoin and paying it out, you may earn money or lose money. I've seen the value of my meager Bitcoin holdings appreciate and depreciate from day to day.

The complication with Bitcoin is that we do not generally receive whole units of bitcoin. They are always fractional units, which complicate the arithmetic. In addition, when we also do not spend whole units of Bitcoin, we spend fractional amounts. Therefore, matching up your incoming coin against several transactions of lesser coin can be tedious.

About the only blessing is that, like FOREX, commission costs are built into the price of your trades.

I'm still not 100% clear on the IRS guidance on Bitcoin because I don't deal with the some of the other conditions mentioned.

Overall, I think you may want to go light on using Bitcoin for day to day transactions, like buying a cup of coffee every morning. The accounting headache might be greater than the coolness factor, at least until software comes along to help you manage these things. In the meantime, your spreadsheet of choice will be the only means of tracking your transactions.
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