Bitcoin as Property: Did the IRS Get It Right?

Source: Thinkstock

Source: Thinkstock

The market doesn’t have to fully accept something in order for it to be taxable — at least, that’s the position that the Internal Revenue Service appears to have taken in relation to bitcoin. On Tuesday, the IRS issued a notice declaring that for tax purposes, virtual curries like bitcoin will be treated as property and explicitly won’t be treated as true currency.

The implications of this notice are fairly significant. Up to this point, bitcoin miners, traders, exchangers, and investors have occupied a legal gray area, operating on the radar but generally outside the jurisdiction of regulatory authorities, including the IRS. The notice simultaneously expands the reach of the IRS and brings bitcoin closer to the mainstream. Ostensibly, this should facilitate the adoption of bitcoin as a more legitimate financial asset or currency (depending on your position). However, it could also add some friction to bitcoin transactions.

It’s important to point out that the ruling treats bitcoin more like a financial asset than a true currency. As property, those who wish to use bitcoin as currency will be perpetually sensitive to both its market value and its basis, or the market value when they received bitcoin either in payment or exchange, or if they generated it through mining. If you realize a gain or loss on the sale or exchange of your bitcoin, the character of that gain or loss will depend on whether bitcoin is being treated as a capital asset (such as a stock or bond) or as inventory or property.

Last year, eBay (NASDAQ:EBAY) CEO John Donahoe said that his company was “looking at Bitcoin closely,” and argued that “Virtual currency is something that’s here to stay.”

Bitcoin is a cryptocurrency that has a few unique properties that make it interesting to traders, investors, and marketplaces. One is a modicum of anonymity. Actors in the bitcoin ecosystem are identified by what amounts to an alias, and precautions can be taken to make it nearly impossible to determine the real-world identify behind that alias. This has some obvious pros and cons, and has popularized bitcoin in online black markets like Silk Road, from which bitcoins worth $28.5 million at the time were seized by U.S. officials when it was shut down.

Above all, the currency is decentralized. Like gold, there is no one central bank that controls it. Price is determined by the market, and supply is created at regular, known rate. Taken together, these factors have made bitcoin increasingly popular as a currency and have put it on the radar of eBay and the U.S. government alike. Too much government attention could be a turn-off for users, though, which is why the tax treatment as property seems to be just right.

Barry Silbert, the chief executive of SecondMarket, which is planning to introduce a new Bitcoin exchange, told The New York Times that ”From a tax perspective, this is really the best possible outcome.”

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