Introduction

I've noticed a significant amount of uncertainty around here about the taxation of
bitcoins. In effort to provide some guidance , I've compiled some of the most common
questions I've seen and tried to provide straight-forward, easy to understand answers. I
am a tax attorney, but there is so much uncertainty surrounding bitcoins that I expect
some people to disagree with one or more of my conclusions. If you have a contradictory
opinion, please share it. We would all benefit from an educated discussion of this issue.
Keep in mind this post is intended for a layman audience. If you are a tax professional or
want a detailed examination of this topic, you find this post lacing. !lease don't nit pic
this post with technicalities or narrow exceptions, I purposely excluded such nuances for
the sae of readability.
I should note that this post does not address aggressive tax planning strategies. "uch
strategies are a lot of fun to discuss, but they do not belong in this type of post. If you are
interested in such strategies, perhaps we can mae a follow-up post on another day.
#egal $isclaimer
%his post was created for general guidance on matters of interest only, and does not
constitute legal advice. &ou should not act upon the information contained in this
publication without obtaining specific advice from a tax professional. 'o representation
or warranty (expressed or implied) is given as to the accuracy or completeness of the
information contained in this post, and I do not accept or assume any liability,
responsibility or duty of care for any consequences of you or anyone else acting, or
refraining to act, in reliance on the information contained in this post or for any decision
based on it.
*I+*,#-+ ./0 $I"*#1",+2 %o ensure compliance with requirements imposed by the
I+", I inform you that any ,.". federal tax advice in this communication is not intended
or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under
the Internal +evenue *ode or (ii) promoting, mareting, or recommending to another
party any transaction or matter addressed herein.
%opic 34 +eali5ation
634 -re gains on 7itcoins taxable8
&es. %his is one of the only unequivocal answers you'll find in this post. ,nder the
Internal +evenue *ode, all income is taxable, regardless of source or form. 7itcoins
present a lot of interesting tax questions, but whether gains are taxable is not one of
them.
6.4 When do my gains become taxable8
&our gains are taxable in the year that they are reali5ed. +eali5ation occurs when you
exchange bitcoins for any type of other property9 such as cash, merchandise, or
services. %his includes everything from haircuts to yachts. 2ssentially, any transaction
involving the exchange or sale of bitcoins is a reali5ation event and triggers taxable gain.
7ecause I've seen a lot of misinformation on this point, I want to mae myself perfectly
clear. If you own bitcoins that have appreciated in value, you cannot use them to
purchase a goods or services tax free. "uch a purchase is an ascension to wealth, and
is therefore taxable. %his is no different than if you had sold the bitcoins for cash and
used the proceeds to purchase the goods or services directly. &et, one would be taxable
while the other would not8 %he I+" would never tolerate such a blatant loophole, and
neither would the courts. In fact, we already have a long line of I+" rulings and "upreme
*ourt cases re:ecting identical arguments made for other types of assets. %he outcome
for bitcoins will be the same.
,nfortunately, this has some serious implications for the future of bitcoin. I have to
question the effectiveness of bitcoin as a medium of exchange when the user has to
calculate his or her tax liability on every single transaction. -s the saying goes, the
power to tax is the power to destroy, and this is no exception.
'ote4 there is a code section that might provide some relief here, but only if bitcoins are
categori5ed as a foreign currency. ,nder this code section, the use of bitcoin to buy
goods and services would be tax free as long as the transaction was personal (i.e. not
for business or investment) and did not generate more than ;.00 of gain.
6/4 What if I sell my bitcoins but do not withdraw the proceeds from the exchange8
It doesn't matter, your gains were reali5ed the moment you sold them. It is irrelevant
whether the proceeds from the sale are ept in your ban account or your exchange
account, you still have a reali5ed gain for tax purposes.
6<4 What if I exchange my bitcoins for altcoins8
%his is a fair question and implicates what is nown as a =lie ind exchange.= #ie ind
exchanges do not trigger reali5ation, and therefore are tax-free. -lthough it's technically
possible for bitcoins and altcoins to qualify for-lie ind treatment, I thin it's exceedingly
unliely. %he regulations for lie ind exchanges require the two property types to have
the same rights, characteristics, and obligations. Whether altcoins and bitcoins meet this
test is uncertain, but I would tend to thin not. -dditionally, if characteri5ed as a foreign
currency, bitcoins would be automatically barred from lie-ind treatment anyways. %hus,
there are two significant legal hurdles that must be overcome before bitcoin and altcoins
can qualify as for lie-ind status. -lthough nothing is for certain when it comes to
bitcoins, I'm fairly confident that lie-ind treatment will fail at one or both of these
hurdles. %hus, I would not suggest that you try to qualify such a transaction as a lie ind
exchange until further guidance on this issue is given by the I+".
6>4 "o how can I avoid reali5ing gains on my bitcoins8
%he only way to avoid reali5ation is to hold your bitcoins without selling or exchanging
them. If you were hoping for a different answer, I'm sorry. Whether you decide to actually
report you reali5ed gains is of course a different matter, but as far as the law is
concerned, you have reali5ed gains upon any sale or exchange of your bitcoins.
6?4 @ow does the I+" now about my gains8
%he I+" only nows what they are told. %his means that they have no nowledge of your
bitcoin transactions unless someone tells them. %here are four ways this can happen.
Airst, bitcoin exchanges or payment processors may report your transactions to the I+"
by filing a form 30BB. @owever, these businesses do not appear to be sub:ect to the
30BB requirements (although that will probably change), and its unliely they would
voluntarily do so. "o for now, this is probably won't happen. Keep in mind that the
exchange or payment processor will need your social security number to file a Aorm
30BB.
"econd, your ban may file a "uspicious -ctivity +eport (="-+=), which could trigger an
investigation for money laundering and tax evasion. 7ans are required to file "-+s for
suspicious wire transfers that are greater than ;>,000. Cost bans are overly cautious
and automatically treat any large international transfer as suspicious. "o, if you transfer
large amounts of money toDfrom an international exchange, its liely your ban will file a
"-+. %his doesn't mean that you are automatically flagged for investigation, but it puts
you on the radar. %he larger andDor more frequent your transfer(s), the more liely it will
become a legitimate red flag that could lead to an investigation. Keep in mind that your
ban is prohibited from telling you whether or not they filed a "-+ against you.
%hird, someone can rat you out to the I+", which happens far more often than you might
thin. %he simple fact is that people get :ealous, and if they've heard that you've made
lots of tax free money on bitcoins, they might get tempted to mae sure :ustice is served.
%here's also that nice reward the I+" will pay them based on how much money the I+"
ultimately recovers from you.
Aourth, you voluntarily and accurately report your gains on your tax return. %hat might
sound ridiculous to some people given the inherent anonymity of bitcoin, but there are
some very rich people in prison right now who used to thin the same thing about their
"wiss ban accounts. %he fact is that penalties for failing to report income are
significant. %his includes the possibility of criminal prosecution. &ou can also add to this
the additional penalties for failing to report foreign financial accounts (discussed below),
which can be even more severe.
-t the end of the day, you have a decision to mae. &ou can comply with the law and
pay taxes :ust lie everyone else, which although annoying, is really not that big of a
deal. -lternatively, you can violate the law and hope that you don't get caught. Caybe
you will, maybe you won't. If you are caught, though, the amount of money you'll be
forced to pay in penalties and interest will drastically exceed the amount you saved.
%hat's not to mention the possibility of a felony criminal conviction and all the negative
consequences that accompany it (including a prolonged stay at *lub Aed). !ersonally, I
have seen the havoc wreaed on people's lives by tax crimes and I would never want to
be in their shoes. 'either should you.
%#9 $+4 Eains on bitcoins are taxable income. %hey become taxable when you sell
bitcoins for cash or exchange them for goods or services. %he I+" does not receive any
direct information regarding your bitcoin transactions, but it has other ways of finding out.
%he monetary and criminal penalties for failing to report gains are not worth the taxes
you'd save.
*ontinued 7elow
.3/ commentsshare
top .00 commentsshow all .3/
sorted by4 best
FGHdblcross3.3F"H ?I points < hours ago
.......*ontinued from !ost -bove.....
%opic .4 +ecognition
6J4 @ow do I calculate my gain or loss8
Eain or loss is calculated first on each bitcoin transaction, then on a an aggregate basis
for the year. 7asically, gain or loss is computed by taing the sales price of each bitcoin
and subtracting it's cost. %he technical terms are amount reali5ed and basis. -lthough
simple in concept, determining amount reali5ed and basis can be quite complex (see
below for more information).
&our tax preparation software will automatically perform these calculations, so the actual
mechanics aren't really necessary for you to understand. @owever, you'll have to now
the basics in order to enter the correct information into the software.
6I4 What is my 7asis8
Eenerally, basis is equal to cost. "o, if you purchase 3 7%* for ;>00, then your basis is
;>00. &ou can also add to this amount any acquisition costs lie broer commissions or
wire transfer fees. "o, let's assume a 3K fee and a ;> wire transfer fee. %his would
mean your basis is ;>00 L ;>0 L ;> M ;>>>.00. If you later sell that bitcoin for ;B00, your
gain would be F;B00H - F;>>>H M F;/?>H.
6B4 @ow do I determine my basis in each bitcoin8
If you own bitcoins that were purchased at different times and at different prices,
determining basis can be quite complex. %his is because bitcoins are fungible. 1nce a
bitcoin is purchased, it becomes indistinguishable from your other bitcoins stored in the
same wallet or account. In a subsequent sale or exchange, there is no way to identify
the bitcoin being transferred out, and therefore you cannot accurately determine its cost
or acquisition date.
*ontrary to what you might have heard, you cannot :ust guess it's cost or arbitrarily
choose the one that gives you the lowest tax liability. %he I+" requires you to use a
system with rules that will produce a reasonable and consistent result. -s long as you
use it year-to-year and the chosen method does not always give you the highest basis
available, the I+" will probably respect it.
%he default system (and the one generally preferred by the I+") is to assume that your
bitcoins are sold in the order they were acquired. %hus, the first bitcoin you purchase is
assumed to be first bitcoin you sell. %his is called the AIA1 method (=Airst in, Airst 1ut=).
%here are some other methods available, such as #IA1 (=#ast In, Airst 1ut=) and
-verage *ost 7asis, but I would caution against using any system other than AIA1 until
additional guidance on this issue is provided by the I+".
I'll note that it's theoretically possible to avoid this problem altogether if you eep each
and every bitcoin purchase in separate wallets or accounts. %his would allow you to
trace the actual cost of each bitcoin you later sell or exchange, alleviating the need for
the AIA1 (or alternative) method.
2ither way, determining cost will require some detailed record eeping. I will discuss
record eeping in more detail below, but remember that the burden to prove basis is on
you. %he I+" will not give you the benefit of the doubt here. If you cannot prove the cost
of each bitcoin, they will assume it was ;0. 1bviously you don't want that to happen, so
eep good records of your bitcoin purchases.
6304 What if I mined my bitcoins, what is my basis then8
%his is a very difficult question to answer with any degree of certainty. %he problem is
that bitcoin mining is a completely unique activity that yields an even more unique
product. %o reach an answer, one must resolve some difficult tax issues. 'amely, what is
bitcoin mining and how do we classify the bitcoins it produces8
,nfortunately, addressing these two issues would be a lengthy and detailed post in itself,
so I cannot fully address them here. "uffice it to say that bitcoin miners will need a very
competent tax advisor to mae sure their gains are properly reported.
'ot to leave you without any guidance whatsoever, the answer will most liely depend
on the si5e and scope of your mining activity. #arge scale miners should probably treat
themselves as a manufacturing business, and the bitcoins they produce as inventory
held for sale to customers. "uch bitcoin miners would not determine their gains in the
same manner as normal investors. %hey would compute income at the end of the year
by figuring their total sales and then subtracting =cost of goods sold.= %he latter would
tae into account the cost of producing bitcoins, such as electricity. 1ther expenses, lie
depreciation on the mining rig, would presumably be deductible as an ordinary business
expenses. 1bviously this implicates some complex accounting rules that are far beyond
this post. - tax advisor with some nowledge of these rules would be needed to
accurately determine your tax liability.
"maller mining operations can probably get away with treating their mining as an
=activity for the production of income,= as opposed to a manufacturing business. In such
a case, they would follow the same rules for determining gain or loss as normal rules
investors. I suspect their basis in this case would be determined by allocating their
mining costs on a pro rata basis, assuming they can reasonably trac and allocate such
expenses (such as electricity). %he safest and most conservative approach, on the other
hand, would be to use a basis of 5ero. $epreciation and other indirect expenses would
liely be deductible as an itemi5ed expense, similar to a general investor (see below).
I must emphasi5e that neither of these treatments is a perfect fit. I expect different tax
advisors to reach different conclusions on the correct treatment. %he goal in any case is
to use the best method of matching income to expenses, whatever that is. !resumably
the I+" will respect your chosen method as long as you can convincingly argue that it is
the best at accomplishing this goal.
6334 What if I received my bitcoins as payment, what is my basis then8
If you sell goods or services and accept bitcoin as payment, your basis in those bitcoins
is equal their fair maret value at the time they were received. Eenerally, this is
determined by reference to the average maret price on that day. %hus, if you wrote a
software program for someone and received 3 7%* as payment on 'ovember 3st, your
basis in those bitcoins is equal to the average price of 3 7%* on that day.
%he choice of which exchange to use for this purpose (e.g. Ct. Eox, 7itstamp, etc.) is up
to you. Whichever exchange you choose, you should have a reasonable explanation for
your choice. &ou should also stic with that choice when computing your gains in the
future. -rbitrarily picing exchange prices that best suit your tax interests will not be
acceptable to the I+" in a subsequent audit.
63.4 @ow do I determine -mount +eali5ed (i.e. "ales !rice)8
%his depends on the transaction and if you sold bitcoins for cash or exchanged them for
goodsDservices.
In the case of a sale, amount reali5ed is equal to sales price, less any selling costs you
incur in the transaction (lie commissions or wire transfer fees). "o, if you sell a bitcoin
for ;B00 and incur a 3K transaction fee, your amount reali5ed is ;B00 - ;B M ;IB3.00.
If you exchanged bitcoins for goods or services (instead of selling them), then amount
reali5ed is more complicated. %his is essentially a barter transaction, where the default
rule is to use the fair maret value of the goods or services received in the exchange.
Aor example, if you purchased a laptop on 'ovember .Bth with bitcoins, your amount
reali5ed would be equal to the Aair Caret Nalue of the laptop on that date. %he easiest
way to determine Aair Caret Nalue is by reference to the sales price, although an
alternative method can be used if yields a more accurate value.
!resumably, the sales price of most goods or services will be denominated in dollars
(even though payment is made in bitcoin). %hus, if the laptop's price was ;3,>00, you
can safely assume that it's ACN was also ;3,>00. If the sales price is denominated in
bitcoin (instead of dollars), you'll have to convert it into dollars using the average
exchange price on that day. -s mentioned above, the choice of which exchange to use
for this purpose (e.g. Ct. Eox, 7itstamp, etc.) is up to you. %he most conservative option
would be to use the price from the exchange that you purchased the bitcoin in the first
place. Whichever exchange you choose, you should have a reasonable explanation for
your choice. &ou should also stic with that choice when computing your gains in the
future. -rbitrarily picing exchange prices that best suit your tax interests will not be
acceptable to the I+" in a subsequent audit.
%#9 $+4 Eain is determined by subtracting basis from amount reali5ed. 7asis is generally
equal to cost, but special rules must be followed (such as AIA1) if your bitcoins are
mixed together. -mount reali5ed is generally equal to sales price. If goods or property
were received instead of cash, then amount reali5ed is equal to the ACN of the property
received.
permalinsave
FGHdblcross3.3F"H </ points < hours ago
.......*ontinued from !ost -bove.....
%opic / *haracter
63/4 -re my gains =capital gains8= !robably. %he first hurdle to clear is the classification
of bitcoins as a capital asset, because capital gains treatment applies only to capital
assets. %his is actually a pretty easy hurdle to clear because the definition of a capital
asset includes all forms of property by default, unless specifically excluded. "o, if you
loo at the list of excluded property under O 3..3(a) of the code, you'll see that bitcoins
are not excluded by name, nor would they fall within any of the excluded categories.
(eep in mind that this is not true if bitcoins are held as inventory in a trade or business,
which might be the case if you mine bitcoins, nor is it true if bitcoins are classified as a
self-created intangible asset lie a copyright or artistic composition, which is unliely but
possible).
%hus, bitcoins are a capital asset in the hands of most taxpayers and qualify for capital
gains treatment. If you were lucy enough to buy your bitcoins more than a year ago,
then your gains would qualify for the lower preferential tax rate given to long term capital
gains (probably 3>K, but it depends on your income level).
If you held you bitcoins for one year or less, then the gains are characteri5ed as short
term capital gains, which are taxed at ordinary income tax rates (i.e. the same rate as
your paychec).
'ote that a different characteri5ation would apply if bitcoins are treated as a foreign
currency. Whether bitcoins will be so treated is uncertain, but if you're curious, read the
answer below.
63<4 What if I mined my bitcoins8
-s mentioned above, the tax treatment of bitcoin miners is very uncertain. %he primary
question here is whether you are engaged in a trade or business, and if so, if your
bitcoins should be classified as =inventory.= If the answer to both of these questions is
=yes,= then your bitcoins are not capital assets and your gains are taxable as ordinary
income. If the answer to either of these questions is =no,= then your gains are taxable
:ust lie a normal investor (i.e. as capital gains).
,nfortunately, there is no clear answer to these questions. Aor some bitcoin miners the
answer will be yes, for others it might be no. %he tax treatment will depend on the
specific facts and circumstances of your case, although the bigger your mining
operation, the more liely it should be treated as a trade or business (and therefore
taxed at ordinary rates). I suggest consulting with a competent tax advisor to determine
whether your mining activities rise to that level.
63>4 What if I'm a =day trader8=
Eenerally, the tax treatment for day traders is the same as a regular investor. 1f course
there are exceptions to this rule, such as the mar-to-maret regime, but they would not
apply to bitcoins without some affirmative directive by the I+".
%here is also the possibility of your day-trading activities rising to the level of an actual
business (which would mae your gains and losses =ordinary.=) %he I+" is extremely
stingy when it comes to classifying day-traders in this manner, though, so it's unliely
you have anything to worry about here. @owever, you should consult with a tax advisor
to be sure about your status.
63?4 What if 7itcoins are classified as a collectible8
-s a collectible, the gains would still be =capital gains,= but the lower tax rate given to
long term capital gains would be fixed at .IK (instead of the 3>K most taxpayers would
use). @owever, it's pretty unliely at this point that bitcoins would be classified as a
collectible. Airst, bitcoins are not specifically named in the code section that defines
=collectibles.= "econd, collectibles are traditionally limited to tangible assets, whereas
bitcoins are intangible assets. ('ote4 there might be an argument that physical bitcoins,
such as those made by *asacius, are =collectibles.= @owever, that would still require
some declaration by the I+" or *ongres to mae certain). %hus, for now, it's safe to
conclude that bitcoins are not a collectible and regular long-term capital gains treatment
applies.
63J4 What if bitcoins are treated as a foreign currency8
-s a foreign currency, bitcoins would be disqualified from capital gains treatment (even
though still technically a capital asset). In other words, all bitcoin gains would be taxable
at ordinary income tax rates regardless of holding period. -lthough this sounds lie bad
news for bitcoin investors, there are some caveats that arguably outweigh the negatives
of this outcome .
%he biggest is the exception under the foreign currency rules for =personal transactions.=
,nder this exception, gains of less than ;.00 are tax free as long as the transaction is
not for investment or business purposes. +emember that without this exception, every
exchange of bitcoins for goods or services would trigger taxable gain, which creates a
significant burden on the use of bitcoin for day-to-day transactions. %hus, this exception
is a potential game changer for the future of bitcoin. -ssuming that most consumer
transactions would generate less than ;.00 of gain, there would be no tax
consequences to the use of bitcoin for personal spending. %he implications of this
outcome cannot be overstated.
If the gains are greater than ;.00 (on personal transactions), they are no longer tax free.
@owever, instead of being taxed as ordinary income, the code allows them to be treated
as capital gains instead. %hus, the gains would be eligible for the lower tax rate given to
long-term capital gains . -lthough not as significant as the ;.00 exemption mentioned
above, this still offers a benefit to consumers who use bitcoin for day-to-day personal
transactions.
Pust to be clear, any gains on non-personal transactions would be ordinary income. "o,
investors would lose the lower tax rate given to long-term capital gains. @owever, this
isn't as bad as it sounds. Airst, many investors - particularly day traders - do not hold
bitcoin for longer than one-year anyways, so their tax rate is effectively unchanged.
"econd, because they are no longer =capital,= bitcoin losses would be fully deductible
(i.e. not sub:ect to the ;/,000 limitation discussed below). Ainally, investors stand to
benefit indirectly from the ;.00 exemption mentioned above. %hat is because this
exemption should help propel the wide spread use of bitcoin, is liely to be the greatest
catalyst for future maret appreciation.
63I4 "o, are bitcoins foreign currency8
It is impossible to say at this point whether bitcoins are a foreign currency for purposes
of income taxation. 'o ," court has directly addressed this issue, nor has the I+"
published any guidance . %he closest we've come is an obscure federal court decision
written by a Cagistrate :udge involving ban fraud chargers (which has nothing to do
with taxation) and a ruling by Ain*en that bitcoin is not a currency. @owever, the Ain*en
ruling uses an extremely narrow definition of currency that has no application
whatsoever to the issue of taxation.
%hus, bitcoin users and tax professionals are left to guess as to it's proper classification.
%he conservative approach is to treat bitcoin as a normal capital asset until some further
guidance is issued by the I+". %his is consistent with the general attitude towards bitcoin
expressed by the I+", as well as some notable legal scholarship on the issue. When
dealing with uncertainties such as this, it is generally advisable to proceed with the most
cautious option available, which would be treating bitcoin as a capital asset (not a
foreign currency).
%his is not to say that you would be without a basis for treating bitcoin as a foreign
currency. Indeed, bitcoins are intended to serve as a medium exchange and lac any
other functional purpose. ,nlie gold, silver or other commodities that have served as
currency in the past, bitcoins do not have any industrial or commercial usefulness aside
from exchange. %his arguably maes them much more similar to a currency than a
commodity or other capital asset.
1f course, the fact that bitcoins are not minted by any foreign government or ban casts
some doubt as to whether they are truly foreign. @owever, the internal revenue code
does not employ the term foreign currency. It distinguishes currency as being functional
or nonfunctional. Aurther, it declares that only the ," dollar can be a functional currency.
%hus, the fact that bitcoin is not produced by a foreign government is not actually
relevant, because any currency that is not the ," dollar is automatically a non-functional
currency and therefore sub:ect to the foreign currency rules.
In the end, the decision of whether to treat bitcoins as a foreign currency is up to you
(and your tax advisor). %he trouble is that the I+" could subsequently try to undo your
elected treatment and assess the additional tax that would result. 1f course, it's possible
that the I+" will ultimately agree with your treatment of bitcoin as a foreign currency, in
which case you would not be at any ris by adopting the treatment early. I wish I could
provide a more concrete recommendation here, but at this point it's :ust too uncertain.
%l9 $+4 &our gains are most liely characteri5ed as =capital gains.= If bitcoins are
determined to be a foreign currency, the characteri5ation would be different. -dditionally,
there are other exceptions that might apply (particularly if you are a bitcoin miner or a
very active day trader).
permalinsaveparent
FGHdblcross3.3F"H /. points < hours ago
.......*ontinued from !ost -bove.....
%opic <4 $eductions
63B4 What ind of expenses can I deduct as an investor8
&ou are permitted to deduct expenses for the production of income on your tax return as
an =itemi5ed deduction.= @owever, this deduction is fairly meaningless for most
investors. %his is because you must actually itemi5e your deductions instead of taing
the standard deduction, which many taxpayers do not. -dditionally, such expenses fall
within the category of =miscellaneous itemi5ed deduction,= which are only deductible to
the extent they exceed .K of your -d:usted Eross Income. %he .K floor is particularly
troublesome because most investment expenses are pretty insignificant. +ecall that
you've already accounted for commissions and wire transfer fees in determining =amount
reali5ed= and =basis.= &our remaining expenses might include4
Q Investment interest (limited to the amount of your net gains), Q +ent expense for a
safety deposit box (this could arguably be extended to include the cost ,"7 drives for
cold storage), Q *onsulting fees for the tax treatment of bitcoin, Q $epreciation on
equipment used in the production of income, such as your computer (however, you'll
have to allocate the cost of the equipment between personal use and investment use,
which is liely to reduce this deduction substantially in most cases).
In most cases, these deductions will be quite small. 1ther expenses may or may not be
available to you, depending on your specific situation, though. &ou should consult with
your tax advisor to be certain of your deductible expenses.
6.04 What ind of expenses can I deduct as a miner8
If your mining operation is substantial and continuous enough to be considered an actual
business, then you can deduct all of your ordinary and necessary expenses. %his would
include the cost of electricity and depreciation on your mining rig, among others. If your
mining operation is not substantial or continuous, you would deduct expenses lie an
ordinary investor.
-s mentioned above, the tax treatment of bitcoin miners is exceptionally uncertain. "o,
its important that you obtain the advice of a tax professional with regards to whether or
not your activity rises to the level of a trade or business.
%opic >4 +ecord Keeping
6.34 What inds of records should I eep8 &ou are required to maintain records
sufficient for determining the amount of your gain or loss, as well as the holding period of
your bitcoins. %his is a flexible standard and depends on the circumstances. Ideally, you
should maintain a log of all your bitcoin acquisitions and dispositions, including the price,
date, and related address of each transaction. Cany exchanges mae this information
available to you in the form of a downloadable spreadsheet.
6..4 @ow long should I eep my records8
%he I+" can generally go bac and audit your tax returns for a period of / years.
@owever, they can go bac ? years in some cases. %hus, the safest answer is to save
records for ? years (determined from the date you filed you tax return).
6./4 What if I don't maintain records8
&ou are required by law to maintain records, so failing to do so will result in the
assessment of civil penalties against you in a subsequent audit. !enalties aside, it is in
your best interest to maintain records because the burden is on you to prove your basis.
%hus, if you cannot reasonably establish your purchase price, the I+" will assume it is
5ero. %he same goes for holding period (which would cause you to lose the benefit of the
lower long term capital gains rate).
%his assumption can be disastrous if you engage in a lot of bitcoin transactions. Aor
example, imagine a day trader who buys ;.,000 worth of bitcoins after seeing a specific
maret signal, which he then sells shortly after for a small profit of ;300. @e does this
only once per day. If he is subsequently audited and lacs the necessary documentation
to prove his basis, the I+" will assume it was 5ero. %hus, he would be taxable on ;.,300
of gain every day, instead of :ust ;300. %hat is a total taxable gain of ;J??,>00 for the
year, compared to ;/?,>00if he had ept adequate records.
%opic <4 Aoreign account reporting
%he requirements to report foreign accounts are complex and convoluted, such that
many taxpayers and tax preparers overloo them entirely. @owever, the penalties for
doing so are severe - even criminal in some cases. %herefore, I feel compelled to
address the reporting requirements for foreign accounts even though I rarely see any
questions on this issue.
6.<4 What are the foreign account reporting requirements8
%here are two separate reporting requirements under federal law, each created by a
different statute (%he 7an "ecrecy -ct and the Aoreign -ccount %ax *ompliance -ct).
-lthough the exact wording is different between the two statutes, they generally require
reporting of financial accounts held at foreign financial institutions. Whether bitcoin
wallets and exchange accounts fall meet the definitions for these terms is debatable.
6.>4 -re paper wallets sub:ect to the foreign account reporting requirements8
!robably not. %he reporting requirements generally apply to financial accounts held at
foreign financial institutions. It's pretty difficult to imagine that a paper wallet containing
your bitcoins would satisfy this test. @owever, it's believable that the I+" will see a
change to this rule sometime in the future. Aor now, though, it's safe to assume that
paper wallets are not sub:ect to the reporting requirements.
6.?4 -re electronic wallets and accounts at a foreign bitcoin exchange (such as Ct. Eox
or 7%*-e) sub:ect to the requirements8
&es, although there's room for disagreement here. %he answer depends on whether
electronic wallet providers and bitcoin exchanges are =foreign financial institutions,= and
whether an account with one of these exchange is indeed a =financial account.=
,nfortunately, an analysis of these definitions and the myriad of exceptions that apply is
too large of a tas for this post. @owever, because foreign exchange accounts accept
deposits of fiat and provide broerage services, it's hard to argue that they are not
sub:ect to one or both of the foreign financial reporting requirements. %he case against
reporting electronic wallets is slightly stronger, but is still quite wea in my opinion. I
would recommend that bitcoin holders err on the side of caution and report such
accounts (sub:ect to the minimum balance requirements discussed below) until further
guidance is provided by the I+". -s you'll see below, the penalties for failure to file are
tremendous and not worth the ris.
6.J4 What is the minimum account balance for reporting the reporting requirements8
%he first threshold is provided by the 7an "ecrecy -ct and is ;30,000.00. %he test if
whether the total aggregate value of your foreign accounts exceeds ;30,000.00 at any
point during the year. If so, you must report the highest balance for each account during
the year by filing an A7-+ with the I+". %his form is filed separate from your income tax
return and must be received by Pune /0th of each year.
%he second threshold is provided by the Aoreign -ccount %ax *ompliance -ct (A-*%-).
%he test is whether the aggregate value of your accounts exceeds ;>0,000.00 on the
last day of the year, or exceeds ;J>,000 at any point during the year (for unmarried
filers). If so, then you must report the highest balance of each account during the year by
filing Aorm IB/I with your income tax return. 'ote4 this is in addition to the A7-+ filing.
6.I4 What is the penalty for failing to file an A7-+8 %he penalty for failure to file an
A7-+ under the 7"- varies depending on =willfulness.= If your failure to file was not
willful, the penalty is capped ;30,000. If your failure was willful, the penalty is the greater
of ;300,000 or >0K of the highest account balance for each account. *riminal penalties
can also apply.
Willfulness is defined generally as the intentional disregard of a nown legal duty. %he
I+" will typically asserts willfulness if you fail to file A7-+s in multiple years. 1therwise,
the determination will depend on your nowledge, sophistication, and experience as an
investor.
6.B4 What is the penalty for failing to file a Aorm IB/I8 %he penalty for failing to file a
Aorm IB/I with your tax return is an automatic ;30,000.00, increased up to ;?0,000 if
you fail to file after receiving notice from the I+". *riminal penalties may also apply.
-t the end of the day, the penalties for both the A7-+ and Aorm IB/I are severe. It is
not worth the ris of failing to file these forms, :ust as it is not worth the ris of failing to
report your gains.
*onclusion
%he taxation of bitcoins presents some complicated questions. I hope my answers have
been helpful, although I expect they probably generate more questions than they
answer. "uch is the nature of most tax discussions, though. !lease feel free to as any
other questions, I'll do my best to answer them.