Virtual currency has risen in popularity over the last several years, not only for investment, but for use in paying for goods and services. Unlike the U.S. dollar, the IRS does not treat virtual currency (also called “digital currency” and “cryptocurrency”) as currency. It is treated as property, even though it can be used as a form of payment.
That means that if you have had any transactions beyond your initial purchase of virtual currency—you have traded it for other virtual currency (or actual currency); used it to pay for goods or services; or sold it—you have taxable transactions that need to be reported on your income tax return (on Schedule D).
For people regularly dealing in virtual currency transactions, this can add up to thousands of taxable transactions each year. For example, if you use virtual currency to buy pizza, you have a taxable transaction reportable on your income tax return (of course, this is not the case if you buy pizza with U.S. dollars). The gain or loss is determined by the fair market value (“FMV”) of the virtual currency on the date of purchase. If the FMV of the pizza is higher than that of the virtual currency used for payment, then you have a taxable gain. If the FMV of the pizza is lower than the value of the virtual currency, then you have a loss (limited to $3,000 per year).
Similarly, if you exchange virtual currency for other virtual currency, or “real” paper currency, you have a taxable transaction. Depending on how and where the virtual currency is being held, you may also have an obligation to disclose it as a foreign account or asset (on a Foreign Bank Account Report and/or IRS Form 8938).
If you have questions, contact Anderson & Jahde, PC.