IRS declares bitcoin to be property, not currency

After months of speculation, the Internal Revenue Service has released new rules for including bitcoin in annual tax filings (PDF). According to the rules, bitcoin is to be handled as a form of property, rather than currency, meaning bitcoin itself is to be treated like a stock. This puts many bitcoin buyers in the awkward, but not necessarily disadvantageous position of filing their gains and losses under capital gains rules, rather than standard income.

In principle, all transactions in bitcoin would need to be accounted for in exactly the same way as stock transactions. While this seems like an impractical decision by the IRS, and a headache for anyone who actually uses bitcoin to purchase real-world goods and services. As Bloomberg’s Richard Rubin and Carter Dougherty note:

Today’s IRS guidance will provide certainty for investors, along with potential income-tax liability. Under the ruling, purchasing a $2 cup of coffee with Bitcoins bought for $1 would trigger $1 in capital gains for the coffee drinker and $2 of income for the coffee shop.

That said, the open nature of the blockchain and APIs of price-charting websites could effectively automate this accounting process completely. Given the semi-anonymous nature of bitcoin, it seems likely that most small-scale users simply won’t report report their bitcoin holdings at all.

For many of the early adopters who suddenly found themselves with a substantial amount of money, however, this will also mean visiting an accountant for the first time in their lives.

While the rules are clearly timed to coincide with the 2013 tax-filing deadline next month, the implications are much larger. These rules unambiguously legitimize bitcoin as a legally meaningful asset in U.S. tax law. As of today, bitcoin is officially recognized in the U.S., even if the scope of that recognition is still to be determined.

The existence of an official, federal-level ruling on bitcoin’s status as a taxable asset is a sea change from how virtual currencies were treated only last year, when many federal officials either dismissed virtual currencies completely or treated them as side-effects of the online drug trade.

This ruling also has some accounting intricacies even experienced CPAs may not be used to. Even knowing the correct amount of gains to report requires at least some idea how bitcoin works:

For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. 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.

A very good summary of the new rules is currently available on Business Insider, and complete rules are available in the PDF posted above.