If I were to sell you something for $10 and you paid for it in Bitcoins that you bought for $5 dollars, the IRS would view that transaction for me as $10 in income, while you would recognize and be liable for $5 of capital gains. While nothing is that simple, it largely is.
Bitcoin gains and losses
In this first ruling by the service, the IRS was essentially facing the choice of treating Bitcoins as currency or as property. In ruling in favor of property, Bitcoin investors will largely receive the same treatment as stock investors. Investors who hold Bitcoins for over a year will receive the capital gains tax rate of a maximum of 23.8%. Those that hold Bitcoins for less than a year will be subject to the 43.4% top rate that applies to property sold in that time frame.
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With Bitcoin’s dramatic fall over the last quarter, there will be investors who have incurred both large and small losses. With the decision today, investors/taxpayers will, like stock traders, be allowed to subtract capital losses from any capital gains as well as a maximum of $3,000 per year from regular income.
Call for action
Just three months ago, National Taxpayer Advocate Nina Olson called on the IRS to make their policies with regards to digital currency clear to taxpayers. Olson, who runs an independent office within the IRS, wrote the following in an annual report to Congress:
“It is the government’s responsibility to inform the public about the rules they are required to follow. The lack of clear answers to basic questions such as when and how taxpayers should report gains and losses on digital currency transactions probably encourages tax avoidance.”
While the IRS was surely considering what to do with Bitcoin and other digital “properties” before Olson’s report to Congress, Olson and her office will certainly be pleased with the IRS’s quick response.
Not only is this the first substantive ruling regarding Bitcoin and others, the ruling is effective now, applies to past transactions and those made from this point forward. The IRS also said that it would consider some leniency and relief from penalties from those trading before today if they can show “reasonable cause” for their failure to file or underpayments.
While this is hardly enough to make Bitcoin transactions transparent, it’s the first step in the IRS getting its cut.