Tax Consideration of Bitcoin

Bitcoin can be acquired through a process called mining or received in exchange for goods or services. Generally, however, it is more often purchased for money on a number of exchanges, and can be traded on a spot or leveraged basis using margin, futures, forwards, and other derivatives. Though bitcoin is traded on public exchanges, a significant volume of trading is conducted over-the-counter. In addition, bitcoin derivatives and products are offered on both U.S. and non-U.S. exchanges.

On Oct. 9, 2019, the IRS provided answers on its website to 43 frequently asked questions (FAQs) addressing virtual currency transactions. The IRS press release announcing the guidance – consisting of the IRS FAQs (Oct. 9, 2019) and Rev. Rul. 2019-24 – stated that it supplemented Notice 2014-21. Revenue Ruling 2019-24 considered the tax treatment of a cryptocurrency events such as hard forks, and airdrops.

The IRS FAQs (Oct. 9, 2019) expand upon examples provided in Notice 2014-21, apply federal income tax principles to additional situations, and, unless noted, are to apply only to taxpayers who hold virtual currency as a capital asset. IRS FAQs (Oct. 9, 2019), Q&A-1, defines virtual currency in a similar manner as Notice 2014-21: “a digital representation of value [] that functions as a unit of account, a store of value, and a medium of exchange;” however, the IRS FAQs (Oct. 9, 2019) specifically exclude “a digital representation of the U.S. dollar or a foreign currency.” In addition, the term “virtual currency” is further defined to include the “various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency”, and any asset having the characteristics of virtual currency.

IRS FAQs (Oct. 9, 2019), Q&A-3, defines “cryptocurrency” as: “... a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.” This broad, and (ironically) imprecise definition includes any distributed ledger that uses cryptographic credentials to spend virtual currency regardless of it implementing incentives and methods to prevent double-spend attacks (e.g., proof-of-work and emergent consensus in the case of Bitcoin).

The IRS FAQs (Oct. 9, 2019) are intended to address virtual currency transactions for those taxpayers holding virtual currency as a capital asset. Generally, the IRS FAQs (Oct. 9, 2019) address:

1. Fundamental capital gain and loss questions, cost basis of tax lots, and valuation;

2. Property exchanges involving virtual currency;

3. Consequences of cryptocurrency events such as hard forks, airdrops, and soft forks;

4. Compensation- and services- related issues;

5. Gifts and charitable donations of virtual currency;

6. Reporting and recordkeeping.

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