The Internal Revenue Service (IRS) recently amended the nine-year-old rule related to the tax treatment of virtual currency, such as Bitcoin, as property for U.S. federal tax purposes.

In 2014, the IRS defined virtual currency as a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value. The notice indicated digital currencies were not legal tender in any jurisdiction. However, Bitcoin is now recognized as a legal tender in El Salvador, Panama, Paraguay and several other countries. As a result, the IRS modified the original rule to correct the issue.

According to the IRS, this change does not affect the answers to the frequently asked questions (FAQs) in the original Notice. This includes the statement that convertible virtual currency isn’t treated as currency that could generate foreign currency gain or loss for U.S. tax purposes. Additionally, it states the below:

“For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received."

Therefore, if a virtual currency is listed on an exchange, and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

Proper Tax Treatment Assistance

The fact that Bitcoin is now recognized as a legal tender in multiple countries demonstrates the continued interest in and widening popularity of virtual currency — now commonly referred to as cryptocurrency. Today, there are other types of digital assets traded through various exchanges, some of which have limited regulations, but most of which have been described as similar to the "wild west” as far as regulations and safety are concerned. There are even digital art assets available.  

If you have ventured into the digital currency realm and would like to discuss how its tax ramifications might impact your return filing requirements, contact an international tax advisor at Moore Doeren Mayhew.