IRS bitcoin policy leaves questions unanswered

In October of 2014, we published a 3-part series on the taxation of bitcoin and other convertible virtual currency. We noted in that series that the IRS currently treats virtual currency like property, with a basis and a fair market value, making it fairly easy to track when used as an investment - but very difficult to value for tax purposes when used like cash.

Accountants ask for more guidance

In 2014, the IRS published Notice 2014-21 to provide some early guidance on the taxation of digital currency. However, the notice left a number of gaps. On June 10, 2016, the American Institute of Certified Public Accountants (AICPA) asked the IRS for clarity as to how their clients should be reporting their bitcoin and digital currency use. The AICPA's questions all reflect the unique nature and expanded use of this relatively new currency:

• Define "reasonable manner" of determining the virtual currency exchange rate. In the Frequently Asked Questions section of Notice 2014-21, the IRS advised taxpayers to determine the fair market value of their virtual currency by converting it into U.S. dollars at the exchange rate. The exchange rate was to be determined in a consistently applied "reasonable manner." This has proven difficult since there is more than one published exchange for Bitcoin and the value reported on each is rarely the same. The AICPA asked whether "reasonable manner" means that taxpayers should use the average of all the published exchanges for the day, for a specific time of the day, or simply select one exchange and use it consistently.
• Explain how the costs of mining and acquiring virtual currency should be treated. Should cost be part of basis as is the case when acquiring property? Or should it be expensed as paid or incurred as with service activities?
• Explain how gains and losses should be tracked when virtual currency is used like cash. The AICPA noted that it is often impossible to track what the basis was for a particular lot of virtual currency that is later used for the purchase of goods or services. Even when this can be done, the amount of recordkeeping required is excessive, particularly for transactions valued at under $10. Will the IRS accept an alternative manner of determining basis under 26 U.S. Code Section 1012, such as first-in-first-out? Could the IRS implement a rule permitting the exclusion of a minimal amount of gain or loss for personal transactions (such as when buying a cup of coffee with virtual currency)
• Provide guidance that helps determine how transaction rules and regulations apply differently to virtual currency. Does like-kind virtual currency qualify for 1031 exchange treatment? Does the IRC section 453 installment method apply differently to transactions utilizing virtual currency?
• Clarify the character of virtual currency for tax purposes. Is virtual currency that is held by a merchant considered a capital or an ordinary asset? Is it a "commodity" subject to mark-to-market accounting?
• Explain the permissible use, documentation and reporting of virtual currency. Does a charitable donation of virtual currency over $5,000 require a professional appraisal? How should virtual donation values be documented? May retirement accounts hold virtual currency investments? Are there any special reporting rules or requirements if a retirement account holds virtual currency?
• Clarify foreign reporting requirements for virtual currency. Are virtual currency accounts reportable on the FBAR? Are there any additional reporting requirements under FATCA?

We will report on the IRS' responses when they are published. In the meantime, Part 2 will focus on U.S. attempts at regulating virtual currency.