7721 / How is bitcoin and other forms of “virtual currency” taxed?

Until late 2019, the IRS had released very little guidance on the tax treatment of what it refers to as “virtual currency” except Notice 20141, which defined virtual currency as “property,” like collectible coins and antiques, which can appreciate in value. Therefore, virtual currency can be included in taxable income and taxed based the sale or exchange of the virtual property. “Convertible virtual currency” is virtual currency that is convertible into real currencies (e.g., U.S. dollars), or as a substitute for a real currency. Notice 20141 provides the basic tax rules that currently apply to bitcoin, Ethereum and other cryptocurrency transactions.

Under Notice 20141, the IRS generally treats bitcoin and other forms of virtual currency as property (and not currency that is legal tender in the United States or elsewhere). In the IRS’ own words, “Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency.” This means that it is typically subject to capital gains treatment upon sale, exchange or other disposition under the general rules applicable to property dispositions, including intangible property (e.g., stocks, bonds, and collectibles).

A taxpayer who receives bitcoin in exchange for goods or services must include the fair market value (measured in U.S. dollars) of the bitcoin received in gross income. Therefore, if the fair market value of property or currency received in exchange for the bitcoin exceeds the taxpayer’s adjusted basis in the bitcoin, the taxpayer will recognize capital gain (or loss if the fair market value of property received is less than that of the bitcoin).¹ The generally applicable holding period rules can be used in determining whether the gain or loss is long-term or short-term ( Q 699). Similarly, the $3,000 capital loss limitation that can be applied against ordinary income also applies.