Bitcoin is a fairly new digital currency that is not fully understood by many Americans. Only those who grasp the unusual intricacies of this cryptocurrency are able to trade it succesfully – to many, the incredibly volatile bitcoin market seems risky and the idea of “mining” for a currency may seem strange. However, given the growing popularity of this market, there is certainly money to be made trading the currency. Bitcoin is currently trading near all-time highs and the market tends to climb as bitcoin becomes more popular. As this market improves, investors recognize capital gains on their closed positions. To the IRS, capital gains mean one thing: tax revenue.
In March of 2014, the IRS released guidance labeling bitcoin, and virtual currency in general, as “intangible property”. For investors, this means that bitcoin is treated as a capital asset. When you buy bitcoin and sell it at a higher price, that gain is taxed just like a stock or a bond would be taxed. In addition, your taxes will be different depending on how long you hold your Bitcoin before you sell it. Short-term capital gains, on assets held less than a year, are taxed more than long-term capital gains, held greater than a year. Long-term capital gains are taxed as if they are regular income. The IRS also won’t expect you to report unrealized capital gains. So even if the value of your Bitcoin holding increases, you will not be taxed on that increase until you sell the asset.
Many Bitcoin markets are located overseas and therefore carry certain foreign tax implications. Forbes provided this information regarding foreign Bitcoin holdings:
“U.S. residents with a foreign bank, brokerage, investment and another type of account (including retirement and insurance in some cases) who meet reporting requirements must e-file FinCEN Form 114, Report of Foreign Bank and Financial Account. If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing FinCEN Form 114.
The IRS allowed taxpayers to exclude Bitcoin from 2013 foreign bank account filings. It’s not clear if the IRS continues to allow an exclusion of Bitcoin, or Bitcoin derivative contracts, on current year FinCEN 114 filings. Suppose you have Bitcoin or Bitcoin derivative contracts held at a foreign Bitcoin exchange. When in doubt, and considering significant penalties for non-compliance, it’s probably wise to include these Bitcoin accounts on FinCEN 114.”
The Bitcoin market has proven to be lucrative and liquid, but despite its unique nature, it cannot elude the scope of the IRS. In order to protect their bitcoin positions and their general financial security, bitcoin traders should keep in mind these tax rules and implications.
Read more from Forbes.
Read the IRS Virtual Currency Guidance.