The IRS considers cryptocurrencies, including Bitcoin, to be “intangible property.” Investors and traders holding cryptocurrency as a capital asset should use capital gain or loss tax treatment on sales and exchanges, with the realization method. For example, if you buy Bitcoins with U.S. dollars and later sell them for U.S. dollars, a capital gain or loss needs to be reported on that transaction. An exchange of one cryptocurrency for another cryptocurrency is a taxable sale transaction, even though U.S. dollars are not involved in the transaction.
Americans also trade Bitcoin or leveraged Bitcoin contracts on Bitcoin exchanges, and they should report realized capital gains and losses on each trade, even if the trader doesn’t convert underlying Bitcoin back into U.S. dollars.
It’s similar to having a foreign-based brokerage account, denominated in a foreign currency (i.e., Euros), where a trader buys and sells European equities held in Euros, and does not convert Euros back to U.S. dollars during the year. Two potential choices for tax reporting: Convert Bitcoin to U.S. dollars on each purchase and sale transaction using the Bitcoin market price that day denominated in U.S. dollars, or perhaps the IRS will allow using Bitcoin as a functional currency, using an average Bitcoin vs. U.S. dollar conversion rate for the tax year.
The CFTC does not permit American retail customers to trade leveraged Bitcoin contracts on unregistered Bitcoin exchanges. (Read my related blog post: If You Want To Trade Bitcoins, First Learn CFTC Rules.)
Whether it’s legal or not under CFTC regulations, the IRS requires American resident taxpayers to report Bitcoin trading income and losses worldwide on U.S. resident tax returns. It doesn’t matter whether you repatriate funds back to the U.S., or not.
IRS guidance on cryptocurrency
In March 2014, the IRS issued long-awaited guidance (IRS Notice 2014-21) labeling cryptocurrency, including Bitcoin, “intangible property.” Investors and traders hold Bitcoin as a capital asset, so it receives capital gain and loss treatment. The AICPA and others have requested further guidance on virtual currency from the IRS. For investors and traders, I have a few unresolved questions below.
Intangible property is not a security, yet it seems logical that several tax rules for investors and traders are similar, whereas a few others are not.
Cryptocurrency is like securities in these cases
- Use the realization method for sales of cryptocurrency held as a capital asset, which means you defer reporting of the capital gain or loss until closing the position.
- Don’t use mark-to-market accounting at year-end, which means you don’t report unrealized gains and losses.
- Use holding period rules to distinguish between short-term vs. long-term (12 months or longer) capital gains and losses. The long-term capital gains rates are lower than short-term rates, taxed as ordinary income.
- The $3,000 capital loss limitation against other income applies.
- Report each trade separately on Form 8949 (Sales and Other Dispositions of Capital Assets); we assume the IRS does not permit summary reporting. It’s OK to attach a report from your broker listing an accounting for each cryptocurrency trade.
Cryptocurrency is unlike securities in these cases
- I don’t think you’ll have to make wash sale loss adjustments since Section 1091 wash sale rules only mention securities, not intangible property. Hopefully, the IRS will clarify this issue.
- Traders qualifying for trader tax status may not elect Section 475 ordinary gain or loss treatment on cryptocurrency. Section 475 covers securities and commodities, not intangible property.
- Cryptocurrency is not sovereign currency or forex with Section 988 ordinary gain or loss treatment, or Section 1256(g) foreign currency contract treatment. The IRS and CFTC call cryptocurrency “currency,” but not “foreign currency.”
Onshore and offshore cryptocurrency exchanges do not issue American investors or traders a Form 1099B.
Read my prior blog post: IRS Guidance On Bitcoin Transactions.
Nadex offered Bitcoin binary contracts in 2016
The North American Derivatives Exchange, Inc. (Nadex), a U.S.-based CFTC-regulated derivatives exchange, offered Bitcoin binary contracts for part of 2016. On Dec. 16, 2016, Nadex filed a Self-Certification to Delist Bitcoin.
Over the past several years, Nadex issued Americans a Form 1099B for Section 1256 contracts. That’s an advantageous tax treatment with lower 60/40 tax rates, and I doubt whether it’s correct to use Section 1256 tax treatment for Bitcoin binary contracts. (Read Tax Treatment For Nadex Binary Options.)
Bitcoin and foreign bank account reporting
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. (Read Bitcoin Is Not Reported On 2013 FBARs.)
For another update on cryptocurrency tax treatment, read Taxation of Virtual Currency, Jan. 16, 2017, Bloomberg, by Elizabeth R. Carter.