In case you were looking for one more reason to avoid “investing” in bitcoins – despite the recent arrests and disappearances associated with the online currency – the IRS issued a notice this week that should make you think twice.
The IRS says that bitcoins will be treated as property, not currency, for U.S. tax purposes. What this means is that every time you use bitcoins to buy something, you have to consider the cost basis of the bitcoins to determine the taxes you’re liable for (if any) on the “sale” of the bitcoin property. Using bitcoins will be equivalent to selling a stock or bond in order to buy something else; you owe taxes on any gains.
Here’s an example from the land of the latte: Let’s say Starbucks actually allowed you to buy your morning cup using bitcoins (which, as of the writing of this post, it does not). You buy your $4 cup of joe using bitcoin that you had actually acquired nine months ago for $3. The sale would trigger a capital gains tax on $1, and since you held the bitcoin property for less than one year, you’d have to pay a tax of $0.43, or 43.4% of the gain. (Incidentally, if you had held the bitcoin for longer than a year, the tax would be 23.8%.) So, that latte just cost you an additional $0.43 since you used bitcoin instead of U.S. dollars.
So what does Starbucks then do with the bitcoins? Well, if they acquired them as part of their standard business operations (selling you a cup of coffee), and they can use them to buy other inputs for their business (more coffee beans, perhaps) they could account for any bitcoin gains as traditional profit on the sale of goods. However, if they needed to convert bitcoins back to U.S. dollars they would have to make two calculations: the first one just described, and the second being a profit or loss on the disposition of bitcoins, subject to Starbucks’ corporate tax rate.
Not only is the tax itself an important deterrence, but (in our opinion) even worse yet, is that now you have to keep diligent records on the cost basis of all your bitcoin transactions. Yikes. Neither the record keeping, nor the additional layer of accounting, nor the tax liability are required when you instead pull $4 out of your wallet. This is an interesting, and fairly elegant, method conjured up by the IRS to discourage use of bitcoin in the U.S.
UPDATE: Gotta love capitalism. The day after the IRS handed down the bitcoin tax notice, up crops a company ready to help you with that pesky problem: https://bitcointaxes.info/ (not intended as any sort of endorsement from us).