7727 / Are there any issues that individuals or entities using bitcoin should be aware of when engaging in transactions that involve bitcoin or other virtual currency?

It is important that individuals or entities that use bitcoin or other virtual currencies maintain complete and accurate records of all bitcoin transactions to ensure that income and loss is properly accounted for. These records should include the dates that the bitcoin is acquired and disposed of, especially if the taxpayer wishes to use identification accounting. Taxes on bitcoin transactions must be paid in U.S. dollars, not bitcoin, so it is important that the taxpayer have a system in place to convert bitcoin into dollars. The IRS has now specified that absent the ability to use identification accounting, the taxpayer must use the “First-in First-Out” (FIFO) method (see Q ) to account for bitcoin transactions. These records can be extremely important to establishing a taxpayer’s basis in the bitcoin for income tax purposes.

Planning Point: Advisors should be aware that the value of bitcoin and other cryptocurrencies can fluctuate like any other investment, and at times can be very volatile. Presently, advisers should probably consider a cryptocurrency investment to be a highly speculative investment. They may also wish to advise clients who already own such currencies to consider converting bitcoin to dollars on a fairly regular basis if they are not interested or able to take the risks associated with cryptocurrency price volatility. As discussed in Q 7726, most traditional consumer protection systems do not apply to bitcoin transactions, increasing the risk of fraud associated with these transactions, and regulators in the United States and worldwide are taking note. Advisors should proceed very cautiously in recommending investing in such virtual currencies.¹

1.  The SEC and state securities regulators in the US.., and many foreign securities regulators are warning investors about cryptocurrencies, especially ICOs - Initial Coin Offers - (so-called initial coin offers in new virtual currencies). In January 2018, the State of Texas (TSSB) took action against US_-Tec Limited (BitConnect) under Texas Blue Sky laws with an emergency cease-and desist order and later an action for a fraudulent securities issuance in connections with a first so-called ICO in the U.S. Other states are taking similar steps toward regulation of virtual currencies and ICOs. Treating the cryptocurrency as a “security” covered by the jurisdiction’s securities laws (federal and state) seems to be the clear directions of the date of this publication.