By Troy Carter, Austin
The rise in popularity of virtual currency in recent years has forced the IRS to decide how it should be treated for federal tax purposes. Unfortunately, the IRS has only released a single piece of guidance, Notice 2014-21, four years ago and has been fairly silent on the subject since then.
The IRS has deemed virtual currency to be treated as property. That is, gain or loss recognition is required when you acquire and subsequently dispose of virtual currency. However, one major difference between typical items of property and virtual currencies lies with the ease of tracking the transactions. For property such as securities, individuals will receive a statement from his or her broker showing the year-end values and cost basis with gains and losses calculated. On the other hand, virtual currencies have no such reports in most cases. Therefore, any individual who decides to invest or receive virtual currencies must keep up with tracking its value from the instant of purchase or receipt to help with the accuracy of reporting gains or losses for taxes.
Here are a few tips to help with tracking your virtual currency basis:
• How much was purchased? If fractions are purchased, be sure to note the exact number out to eight decimal places in order to minimize any rounding errors.
• How much did you pay for the virtual currency? This amount will be used at a later date when you plan on selling or using it.
• Keep track of each lot of virtual currency separately. It helps to assign each lot a number. This will allow you to accurately record the cost per share, cost basis and ultimately any gain/loss on the sale of the currency.
• When sold, record the amount of cash received in the exchange along with the amount sold from the lot of virtual currency. If the virtual currency was used in a barter transaction, record the fair market value (FMV) of the goods or services received for the virtual currency.
• You must calculate the gain or loss each time a virtual currency is disposed in any fashion.
Once gain or loss has been calculated, one must determine the character of the gain or loss. The character is contingent on whether the virtual currency could be considered a capital asset in the hands of the taxpayer. If so, then the sale is reported as a capital gain or loss with the holding period used to determine long-term or short-term status. Otherwise, ordinary gain or loss recognition is required.
Another issue is how to treat receipt of mined virtual currency. When an individual successfully mines virtual currency, this triggers income recognition. The amount of income that is to be recognized is equal to the FMV of the virtual currency at the date it is mined. It would be advisable to consider whether self-employment tax may apply, as well.
It would be helpful for the IRS to issue additional guidance on this matter. However, with the recent tax law changes, this may end up as fairly low-priority guidance. It will be interesting to continue watching this topic evolve.