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Bitcoin Tax Ruling

posted by Adam Levitin

The IRS has spoken:  Bitcoins are property, not currency.  This was hardly a surprise, but it has some important implication that tells us a lot about what it takes to make a currency work.  


For a payments geek, the real lesson from the IRS Bitcoin ruling is that for a currency--or any payment system--to work, its units must be completely fungible.  One reason dollars work really well as a currency is that one $20 bill is entirely fungible with another $20 bill.  This means that when I pay, I don't have to make a decision about which $20 bill to use (unless I have some idiosyncratic attachment to the crisp ones or the like). It means that when I accept a payment, I don't care which $20 bill I am given, in part because I know that my ability to spend that $20 bill will not depend on which $20 bill it is.  If payment were in, say, camels, then it would probably matter a great deal which camel were tendered.  Camels aren't fungible. And we know that's not going to make for a very good payment system. 

So what does this have to do with Bitcoin?  

The IRS ruled that Bitcoin and other virtual currencies are property, not currency.  This means that they are subject to capital gains taxation.  And that means that Bitcoins are not fungible.  The price at which a particular Bitcoin was acquired (and this is traceable) determines the capital gains on that particular Bitcoin when spent.  If I spend Bitcoin A, which I bought at $10, but is now worth $400, I’ve got a very different tax treatment than if I spend Bitcoin B, which I bought at $390. (Poor Satoshi--he's got a lot more capital gains than most...)  This means Bitcoins are not fungible, and that makes it unworkable as a currency.  If I have to figure out which particular Bitcoin in my wallet I want to spend and what the tax treatment will be, Bitcoin just doesn't work as a commercial medium of exchange.  Bitcoin still works as a speculative medium, but Bitcoin's claim has always been to being more than the latest iteration of the trading sardines--it aspired to be a commercial medium.  I don't see that happening now.  



Doesn't it also mean that sales tax is owed when you trade bitcoins for dollars? Which is not the case when you trade yen for dollars.

No. There is no general federal sales tax. We only have federal sales taxes on a few specific items, such as gasoline, cigarettes, and indoor tanning services. Sales taxes are generally a state tax issue, and the IRS ruling only determines federal law. Whether Bitcoins are subject to sales tax at the state level depends on what individual states decide Bitcoins to be. It's quite possible that we end up with a hodge-podge of state rulings and then an even bigger problem of determining where the transactions took place and hence what state's law applies.

Right but you have to figure that most states will defer to the IRS on the definition of "property" since most state tax codes either don't define that word or use the exact same definition as the federal definition...

If states follow the federal government, then yes, sales tax would presumably be due when purchasing or redeeming Bitcoins from an exchange. There's still the question of which state's laws would apply, particularly if the Bitcoin exchange is based overseas.

Well ... yes, you're right. But what did the IRS announcement do to the price of Overstock.com's stock?

Here's where it gets fun, though. A $20 bill that I obtained back in 1989 had a FAR different value then than it does, today. Shouldn't I get to claim a capital loss, based on the Fed's devaluation of my $20 bill?

If that 1989 $20 wasn't currency, but was property, then sure, you'd get a capital loss. But currency treatment both helps and hurts.

As for Overstock.com, I wouldn't think there'd be any effect--how many transactions have they actually done with Bitcoin? Very few, I suspect.

Wouldn't this mean that paying in Bitcoin is a barter transaction? Would Overstock, or any other retailer, be able to collect sales tax etc. on any transaction utilizing Bitcoin?

I suspect laws exist, but how do state or federal tax collectors handle barter transactions?

Yeah, but I don't care if you pay me with "Bitcoin A" or "Bitcoin B" so it still seems fungible to me. Which you choose is your problem. It also depends on your accounting method, FIFO/LIFO. As a thought experiment send A and B to the same address to create "Bitcoin C". Now it is all down to your accounting method to decide how much tax you owe for that purchase or sale of bitcoin. This is a nonissue for fungibility.

Now if "Bitcoin A" came from a tumbler and "Bitcoin B" came from your Coinbase account we can start to talk fungibility. What is the relative change in value I perceive now?

I'd guess most people aren't dealing with entire bitcoins to begin with. All my bitcoin arrived in tiny fractions, usually .02 btc or less. So if I sell 20 bitcoins, how is the IRS ever going to figure out the capital gains on the thousand tiny transactions that came together in my wallet to form that 20 bitcoins? I assume folks doing automated stock trading run into the same issue while doing thousands of buys and sells - how do they handle it?

Also, doesn't that mean if I buy a car with bitcoin, I'm not "buying" a car, I'm bartering for it? It would be no different than trading a piece of art for the car according to the IRS. So wouldn't I only owe a capital gains tax if I made a net gain on the transaction? (just guessing here, I have no idea how the IRS handles bartering)

As President Andrew Jackson famously said about John Marshall's Supreme Court, "They have made their decision. Now let them enforce it."

That isn't how fungibility works.

Quite simply, the exact same laws exist with regards to currency transactions, stock transactions, and commodity transactions. The price as which you purchased the good or currency is the basis for which your capital gains on the sale are calculated. But this does not mean that any of those things (foreign currencies, Gold, Stocks in the same company at the same level) aren't fungible.

If it is the case that the IRS wants to delineate between coins this is actually advantageous for BTC owners, as they would be able to choose of the available coins if they were so delineated to transact with and so choose the basis for taxation.

But nothing says the IRS has to do so or that such a regime would ruin BTC as a currency. It would just make your accounting a bit more complicated unless you used a simple rule like LIFO or FILO.

The IRS doesn't have to figure it out. You do. It's possible, but it takes some work, and Bitcoins leave a digital trail that makes it possible. The IRS can then decide if it wants to audit you. If you haven't declared the income, you've got a big problem. Even if you have declared it, the IRS is entitled at that point to calculate the taxable income itself, and if they don't agree with you, it's a problem. Either way an audit is a major pain and even if a remote risk, it makes it not worthwhile to mess with Bitcoins except as an investment media. No one wants audit risk for a commercial medium.

A better way to say it would be that the key part of fungiblity is not the basis for which the person selling it acquires it but the basis for which the person purchasing it uses for the purposes.

If you have two BTC, one purchased at 10 and one at 200. And you sell either one to me at 340 my basis is 340 regardless of which BTC you sell to me.

Great points, Adam. I was likewise intrigued by the implications of the IRS decision for the currency, though I came at it from a slightly different way. I think the upshot will be to privilege Bitcoin currency exchange services. The IRS decision seems to place a premium on recordkeeping, and services like Coinbase do that automatically. If you're interested (shameless plug alert): http://justshilling.wordpress.com/2014/03/25/big-winner-of-the-irs-rule-treating-bitcoin-as-property-coinbase/

The point about barter is interesting. If bitcoin is property and I "buy" other property with it, I'm actually bartering (at least as far as the IRS is concerned). So in the example of buying a car with bitcoin, you'd have to know the dollar value of the car and the bitcoins, and you pay tax only if you "made a profit" on the barter. Or that's my take anyway.

Another lesson from the IRS ruling is that currency has been politicized on the pretexts of law and order, economic stability, economic growth, paying one's fair share, etc., etc., etc. No one, says the IRS, has the right to benefit from the use of money but with the permission of small cliques of people who control large, open air farms known as countries, esp. a very large farm called the United States of America.

But all this has been known for generations. So, I'd like to introduce an issue that appears to be unrelated but which is directly relevant to slowing down the IRS:

How could the clause of Article VII of the Constitution have stated the law about "Establishment" before the Constitution was established? To assume that it did so presupposes what's at issue. So, it's just not clear that A7 ever had anything licit to say about establishment unless it merely restated law established severally from the Constitution. None of the Constitution's apologists, however, make such a claim. Thus it stands to reason that the great Constitution is a hoax. It's not the supreme law of the land; nor is it the foundational law of a land. In fact, it's not a law at all.

We can take our analysis just a little further, now. If the clause of A7 had stated the law of "Establishment" in Sept. 1787, it would not have been necessary to include A7 in the first place. (Need I explain why in a forum rife with lawyers?) Yet there it is anyway, just waiting for knaves to make use of it when coaching dupes to accept the republican faith.

I really don't know what makes bitcoins any different from any other foreign currency, except it's virtual and mathematically protected against inflation.

btc is hence totally fine as a currency.

Bitcoin isn't always traceable. If your bitcoin goes through a mixer, then the origin of your bitcoin cannot be traced. Furthermore, being property does not place an obligation on the user to sell a particular bitcoin for a particular price because of where the bitcoin came from.

For example, Gold is property, and is physically distinct, and gold can be bought and sold. But I don't know of any requirement for particular gold to track its particular buying price along through a sell in order to compute a tax.

Thinking through manufactured goods, I am pretty sure this is a made up requirement on the part of the author. Because clearly many sources of parts might be used in the construction of a product, and those prices may vary. I don't know of any requirement that the cost of selling a good requires the tracking of the costs to go into that particular good.



'The rulings won’t hinder bitcoin’s use on a daily basis for simple purchases, according to Keith Aqui, the IRS staffer who wrote the notice. “I don’t think they have to worry,” Mr. Aqui told MoneyBeat, referring to people using bitcoin to make regular purchases. If the digital currency isn’t being held as an investment, he said, it won’t be subject to property taxes. “It all depends upon your intent in holding onto the bitcoin.”

In other words, the next time you buy a slice at Lean Crust Pizza in Brooklyn (yes, they take bitcoin), you won’t have to calculate the capital-gains tax on that purchase. (Paul Vigna)'

I guess you must have bombed this classic SAT question...

Imagine the price of bitcoin is $400. You hold a total of 2 bitcoin, together worth $800. You acquired bitcoin A for $10. And you acquired bitcoin B for $390. Without including taxes if you spent all of your bitcoin you would realize a gain of $400 or 100% on your combined bitcoin investments. Now imagine that bitcoin A is taxed at 60% and bitcoin B is taxed at 40%. Having spent $10 on bitcoin A, which is now worth $400, you stand to gain $(390-(390*.6)) = $156 after taxes. Having spent $390 on bitcoin B, which is now worth $400, you stand to gain $(10-(10*.4)) = $6 after taxes.

Which bitcoin should you spend?
a) Bitcoin A (because you'll make higher gains).
b) Bitcoin B (because you'll be taxed at a lower rate).
c) It makes no difference (because no gains are realized until the bitcoin is spent, and either bitcoin buys an identical basket of goods i.e is fungible).
d) The crisp one.

Which bitcoin should a vendor prefer?
a) Bitcoin A (because it's luckier).
b) Bitcoin B (because it has less tax baggage).
c) Either or (because they're both worth the same i.e. they're fungible).
d) I eat paste.


The WSJ article is plainly wrong. I don’t know if it’s a matter of the reporting or of what the IRS guy said, but it is pretty plainly wrong. First, it’s not an issue of a “property tax”. It’s about income tax. Second, one’s “intent in holding onto the bitcoin” has only limited relevance for its federal tax treatment. All realized gains on all capital assets are taxable. Virtually all assets are capital assets (major exclusions are inventory and tools of trade). Your house, your car, your pants, your watch—those are all capital assets. If you realize any gain on their sale, it’s taxable as capital gains (we have a limited exclusion for gains on one’s primary residence, but that proves the point). It doesn’t matter whether the property is held for personal use or investment. If you realize a loss on a capital asset, then you can deduct it from your capital gains, but only if it was a capital asset held for investment. In other words, intent does not matter for recognition of gains, only for recognition of losses. That’s not helpful for Bitcoin. Every time you use a Bitcoin, there is a capital gains tax issue, just as if you were buying and selling cars on a daily basis. Even if your taxes net out to zero, there’s still a helluva lot of record keeping necessary. That’s not commercially practicable. btc ain’t gonna work as a commercial medium of exchange.

See here for some support (I can go through IRC chapter and verse, but I don't think anyone really wants that): http://www.irs.gov/uac/Ten-Important-Facts-About-Capital-Gains-and-Losses

@Sean Thayer:

Open wide, ‘cause here comes the paste. Your post is obnoxious, but I don’t think you understand how the basic point of my post, much less how capital gains taxation works. There’s no question that there’s a bigger gain on Bitcoin A than Bitcoin B, even net of taxes. But the economic gain isn’t really relevant. It doesn’t affect the purchasing power of the Bitcoins, which is the same for both Bitcoins. More importantly, the fact that there’s a larger gain on one Bitcoin than the other doesn’t mean that one doesn’t want to try to minimize taxes. (And for inheritance planning, spending Bitcoin A would be particularly foolish, as it would deprive your heirs of a large step up in basis—untaxed appreciation.) Second, your hypothetical doesn’t make a lot of sense. Capital gains tax rates aren’t going to vary between Bitcoins. The size of the gains that are taxed will vary. And that matters because all else equal, one wants to reduce the amount of one’s capital gains so that one’s taxes will be lower. That means one cares about which Bitcoin one uses.

I fail to see, probably because I know very little about tax laws, the difference between this week's IRS Notice and the only possible alternative, namely bitcoins are declared a foreign currency:

Assume I am a waiter in a bar, getting tipped in Euro. Occasionally the patrons pay for their beer in Euro too. I, as well as the bartender, duly record each received Euro and its USD value at that moment of receipt.
The following year I, as well as the bartender, spend the Euros on some purchased goods in Europe, and duly record the USD equivalent at time of purchase of goods.

Per tax rules, I need to pay capital gain tax on the difference in Euro-USD exchange rate at the time of receiving the Euros and at the time of expenditure.
Now If I change Euros to bitcoins (declared as property by the IRS) in the above story, will it be any different from the tax liability and reporting pov?
If no difference, then I surmise that declaring bitcoins as property or as foreign currency (like the Euro above) would have the same effect. No?

1. I specifically mentioned a waiter and a bartender, in case of different treatment between individual and a business.
2. If it is illegal to get Euros in the US as a payment, let's move the bar to Europe. US tax laws still apply to US persons over there.

There's a post from a tax attorney on reddit that states the following:

"#2 Every bitcoin transaction is taxable.
As I said in my first post, Bitcoin users will have to calculate their gain or loss every time they purchase goods or services with bitcoin. Yes, this is a very onerous burden and creates a significant threat to the widespread adoption of bitcoin. However, this outcome is not very surprising and is consistent with US tax laws. Hopefully the Treasury Department or Congress can be convinced to apply a "personal transaction" exception similar to the one that exists for foreign currency. But for now, this is how it will have to work.
When calculating your gain or loss, you must determine "amount realized" and "basis." When buying goods or services with bitcoin, the amount realized is equal to the fair market value of whatever you received. When selling bitcoin, the amount realized is the sales price less any transaction fees.
The biggest issue for most bitcoin users is determining their basis. Because bitcoins are fungible, you run into the problem of tracing the cost of each bitcoin you hold. You cannot just arbitrarily choose your basis. The IRS will permit you to use the FIFO method (First in, First out). Any other method such as LIFO or Average Cost Basis is not advisable, particularly now that we know foreign currency rules do not apply."

I'm personally not sure how true this is but it seems to suggest that they are indeed fungible.

Payers don't have to report barters worth under 600 dollars. So bartering an orange for a bitcoin means you obtain the bitcoin, and then next time you spend it, it's a capital loss or win.

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