Taxable Bitcoins: Property or Money?

Is Bitcoin currency or property? It depends on which parts of the federal government you ask. Last week the Internal Revenue Service (IRS) announced that bitcoins are taxable and how it would implement such taxation. While the rule could have been much worse, the manner in which the IRS went about doing so brings up many more legal questions.

In context, the fluctuating exchange rate between bitcoins and dollars does cause the cryptocurrency to behave more like property in terms of valuation. The IRS merely took its explanation on “virtual currencies” from the current definition of taxable bartering:

Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as fair market value unless the value can be shown to be otherwise.

This is clearer when seeing the IRS’s answer to how Bitcoin values must be calculated for tax purposes:

…A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

This classification of Bitcoin as non-currency for tax purposes isn’t that new. Back in January 2014, Sweden’s Tax Agency moved to classify bitcoins as assets rather than currency itself. In Australia, this month, the tax authority announced Bitcoin transactions person-to-person would be subject to a “goods and services” tax, similar to the IRS classification, as well as a capital gains tax for profits made through Bitcoin. It is not unusual for bitcoins to be treated as non-currency for tax purposes.

Of course, the IRS had an alternative route to tax Bitcoin transactions using the capital gains tax, as described here:

Foreign currency transactions: If you have a gain on a personal foreign currency transaction because of changes in exchange rates, you do not have to include that gain in your income unless it is more than $200. If the gain is more than $200, report it as a capital gain.

Even if the IRS didn’t use the “value added tax” standard, Bitcoin users would still be liable to file their income in bitcoins as a foreign currency, as described below:

Foreign income: If you are a US citizen or resident alien, you must report from sources outside the United States (foreign income) on your tax return unless it is exempted by US law… This applies to earned income (such as wages and tips) as well as unearned income (such as interest, dividends, capital gains, pensions, rents, and royalties).

As previously stated, the decision to base taxation on the “value added tax” standard rather than the capital gains standard is likely due to Bitcoin’s fluctuating exchange rate. So, as to avoid confusion and cheating on reporting income, the IRS likely ended up choosing to define bitcoins as property (or a commodity) and have a more accurate definition for taxation purposes.

Despite the IRS’s classification Bitcoin itself has already been acknowledged as currency from a federal court decision. Bitcoin exchanges also have to register as money service businesses, that is, businesses which handles currency exchanges or acts as a money transmitter. So the cryptocurrency is considered money under all other circumstances, except for taxation. This distinction must remain solely applicable to cases within the IRS, or else a vast number of legal questions could arise in Bitcoin disputes.

Ultimately whether Bitcoin is classified as property or currency is a minor concern, as long as governments don’t stamp out this innovation, as they have countless others, with mounds of red tape. Let’s have light, transparent rules that let the market ultimately decide what Bitcoin is.

CEI Senior Fellow John Berlau contributed to this post.