Report: How to file bitcoin on your tax return

As bitcoin becomes a growing part of forward-thinking investors’ portfolios, there’s one huge unresolved question: How do I report it in my taxes? With many newly minted “bitcoin wealthy” investors in 2013, it’s not a small question, particularly as April 15 approaches.

Unfortunately, the U.S. government isn’t even sure how to classify bitcoin at the moment, given that the Federal Reserve doesn’t believe it to be a currency and the Commodity Futures Trading Commission hasn’t yet declared it to be a commodity. Bitcoin exists in the kind of legal limbo that drives accountants crazy.

According to Business Insider, however, this doesn’t mean every holder of bitcoin has an audit in their future. According to San Diego tax attorney Tyson Cross of BitcoinTaxSolutions.com, a little common-sense thinking and basic tax knowledge is all you need to keep on the IRS’s good side.

Bitcoins are taxable, Cross says, just like any income. If you gained an asset from anywhere, regardless of what form that asset takes, its value counts for tax purposes. But different kinds of assets are taxed in different ways, so the big question is “What kind of asset description best applies to bitcoin?”

That’s a decision for the IRS to make, but Cross does have an informed guess:

We’ve narrowed it down to two likely categories: as a foreign currency or capital gains item or a capital asset. So when choosing between those two alternatives, there’s two considerations I tell people to make. The first is that capital asset has a very broad definition that almost certainly includes bitcoin. So reporting it as a capital gains is probably the safest route as far as meeting requirements of laws. On the other hand, while there’s a much more narrow definition of foreign currency — and it’d be much more difficult to do that without taking a risk that the IRS won’t agree — the tax you pay is higher. So there’s an argument that it’s safer to go that route, because if in the future the IRS decides it’s a capital asset, then you’re entitled to refund, and if they go the other way, then don’t have anything to worry about.

Fair enough, but what about miners? After all, they didn’t buy the bitcoin, they created it.

There are a couple different schools of thought out there. One group says you receive taxable income when Bitcoin is first mined, once it’s agreed on the Blockchain, and then again once you sell it; the other school says it’s only taxable on the sale. I have a couple clients who do mining, and addressing the situation is hard — there’s no clear answer to that, there’s never been anything like bitcoin mining. At the current time, it depends on your exact situation, there is no one clear answer. It depends on which is more favorable to the client, and how risk averse they are.

Cross also notes that state governments are likely to follow IRS rulings, and that while it may be years before the IRS actually comes up with a clear statement on bitcoin, those holding cryptocurrencies are still going to be on the hook for what they owe.