04-30-2025, 02:28 PM
#12: What if I received my bitcoins as a gift, what is my basis then?* It depends. Generally, you inherit the basis of anything given to you as a gift. This means you would take the same basis as the friend who gave you the bitcoins. However, an important exception applies if the friend’s basis was more than the market value of the bitcoins at the time of the gift (i.e. the bitcoins had a built in loss).
In that case, you would wait to determine your basis until you sell or exchange the gifted bitcoins in the future. When the time comes, you would use the following rules:
· First, calculate your gain/loss using your friend’s basis.
· If this results in a gain, then the default rule applies and nothing changes.
· If this results in a loss, however, then you do not inherit your friend’s basis. Instead, you must use the market value of the bitcoins on the date of the gift and recalculate your gains/loss.
· After recalculating, you must check if you still have a loss. If yes, then proceed with using the market value as your basis. However, if the recalculation results in a gain, then the tax law says to ignore the gain and report nothing. To be clear, you have no gain or loss in this situation.
Now that last point might confuse many readers, so here is an example to demonstrate. Assume you received bitcoins worth $750 at the time of the gift. Your friend’s basis was $1000. This triggers the exception discussed above and you have to wait until you sell the bitcoins in the future to determine your basis. Consider three alternative sale prices:
· Sale Price = $1200. Using your friend’s basis of $1000, this creates a gain of $200. Therefore, you inherit your friend’s basis and have a realized gain of $200. No problem.
· Sales Price = $600. Using your friend’s basis of $1000, this creates a loss of $400. Therefore, you cannot inherit your friend’s basis. Instead, you must use the value of the bitcoins on the date of the gift, which was $750. Therefore, you have a loss of $150. No Problem.
· Sales Price of $900. Using your friend’s basis of $1000, this creates a loss of $100. Therefore, you cannot use your friend’s basis. Instead, you must recalculate your gain/loss using the value of bitcoin on the date of the gift. Now you have a gain of $150. Therefore, you disregard the sale and have no gain or loss to report.
· This is a perplexing tax treatment. It might help to think of this rule as preventing your friend from shifting bitcoin losses to your tax return. This is why you get to inherit his basis only if it would create a gain on the subsequent sale. If not, then the amount of his loss is extinguished and you get to recognize only the amount of loss that accrued after the gift occurred. This also explains why you would have no gain or loss if the market price of bitcoin has increased since the time of the gift but is still less than your friend’s original basis.
· In any case, when receiving bitcoins as a gift, make sure to ask the person what his or her basis was in the bitcoin, as well as their acquisition date (which you always inherit). Lastly, write down the date of the gift and the market price of bitcoins on that day.
· #13: How do I determine Amount Realized (i.e. Sales Price)?
· This depends on the transaction and if you sold bitcoins for cash or exchanged them for goods/services.
· In the case of a sale, amount realized is equal to sales price, less any selling costs you incur in the transaction (like commissions or wire transfer fees). So, if you sell a bitcoin for $900 and incur a 1% transaction fee, your amount realized is $900 - $9 = $891.00.
· If you exchanged bitcoins for goods or services (instead of selling them), then amount realized is more complicated. This is essentially a barter transaction, where the default rule is to use the fair market value of the goods or services received in the exchange. For example, if you purchased a laptop on November 29th with bitcoins, your amount realized would be equal to the Fair Market Value of the laptop on that date. The easiest way to determine Fair Market Value is by reference to the sales price, although an alternative method can be used if yields a more accurate value.
· Presumably, the sales price of most goods or services will be denominated in dollars (even though payment is made in bitcoin). Thus, if the laptop's price was $1,500, you can safely assume that its FMV was also $1,500. If the sales price is denominated in bitcoin (instead of dollars), you'll have to convert it into dollars using the average exchange price on that day. As mentioned above, the choice of which exchange to use for this purpose (e.g. Mt. Gox, Bitstamp, etc.) is up to you. The most conservative option would be to use the price from the exchange that you purchased the bitcoin in the first place. Whichever exchange you choose, you should have a reasonable explanation for your choice. You should also stick with that choice when computing your gains in the future. Arbitrarily picking exchange prices that best suit your tax interests will not be acceptable to the IRS in a subsequent audit.
TL; DR:Gain is determined by subtracting basis from amount realized. Basis is generally equal to cost, but special rules must be followed (such as FIFO) if your bitcoins are mixed together. Amount realized is generally equal to sales price. If goods or property were received instead of cash, then amount realized is equal to the FMV of the property received.
Topic 3 Character
#14: Are my gains "capital gains?" Probably. The first hurdle to clear is the classification of bitcoins as a capital asset, because capital gains treatment applies only to capital assets. This is actually a pretty easy hurdle to clear because the definition of a capital asset includes all forms of property by default, unless specifically excluded. So, if you look at the list of excluded property under § 1221(a) of the code, you'll see that bitcoins are not excluded by name, nor would they fall within any of the excluded categories. (keep in mind that this is not true if bitcoins are held as inventory in a trade or business, which might be the case if you mine bitcoins, nor is it true if bitcoins are classified as a self-created intangible asset like a copyright or artistic composition, which is unlikely but possible).
Thus, bitcoins are a capital asset in the hands of most taxpayers and qualify for capital gains treatment. If you were lucky enough to buy your bitcoins more than a year ago, then your gains would qualify for the lower preferential tax rate given to long term capital gains (probably 15%, but it depends on your income level).
If you held you bitcoins for one year or less, then the gains are characterized as short term capital gains, which are taxed at ordinary income tax rates (i.e. the same rate as your paycheck).
#15: What if I mined my bitcoins?
IRS Notice 2014-21 clarified that bitcoin miners have income in the year the bitcoin is mined. The notice is silent as to the character of this income, but it is probably ordinary.
When the miner later sells the bitcoin, the gain is also taxable. The character of that gain is probably capital for the reasons discussed above. However, if your mining activity rises to the level of a "trade or business" and you bitcoins can be considered as "inventory held for sale to customers," than the gain is ordinary income.
Whether your bitcoins are "inventory" depends on the facts and circumstances of your particular situation. Generally, if you sell bitcoins to an exchange, your bitcoins are probably not inventory. If you sell them to a specific person or list of persons/companies, then it's possible they are inventory. I suggest consulting with a competent tax advisor to determine whether your activity is a "trade or business" and whether your bitcoins are "inventory held for sale to customers."
In that case, you would wait to determine your basis until you sell or exchange the gifted bitcoins in the future. When the time comes, you would use the following rules:
· First, calculate your gain/loss using your friend’s basis.
· If this results in a gain, then the default rule applies and nothing changes.
· If this results in a loss, however, then you do not inherit your friend’s basis. Instead, you must use the market value of the bitcoins on the date of the gift and recalculate your gains/loss.
· After recalculating, you must check if you still have a loss. If yes, then proceed with using the market value as your basis. However, if the recalculation results in a gain, then the tax law says to ignore the gain and report nothing. To be clear, you have no gain or loss in this situation.
Now that last point might confuse many readers, so here is an example to demonstrate. Assume you received bitcoins worth $750 at the time of the gift. Your friend’s basis was $1000. This triggers the exception discussed above and you have to wait until you sell the bitcoins in the future to determine your basis. Consider three alternative sale prices:
· Sale Price = $1200. Using your friend’s basis of $1000, this creates a gain of $200. Therefore, you inherit your friend’s basis and have a realized gain of $200. No problem.
· Sales Price = $600. Using your friend’s basis of $1000, this creates a loss of $400. Therefore, you cannot inherit your friend’s basis. Instead, you must use the value of the bitcoins on the date of the gift, which was $750. Therefore, you have a loss of $150. No Problem.
· Sales Price of $900. Using your friend’s basis of $1000, this creates a loss of $100. Therefore, you cannot use your friend’s basis. Instead, you must recalculate your gain/loss using the value of bitcoin on the date of the gift. Now you have a gain of $150. Therefore, you disregard the sale and have no gain or loss to report.
· This is a perplexing tax treatment. It might help to think of this rule as preventing your friend from shifting bitcoin losses to your tax return. This is why you get to inherit his basis only if it would create a gain on the subsequent sale. If not, then the amount of his loss is extinguished and you get to recognize only the amount of loss that accrued after the gift occurred. This also explains why you would have no gain or loss if the market price of bitcoin has increased since the time of the gift but is still less than your friend’s original basis.
· In any case, when receiving bitcoins as a gift, make sure to ask the person what his or her basis was in the bitcoin, as well as their acquisition date (which you always inherit). Lastly, write down the date of the gift and the market price of bitcoins on that day.
· #13: How do I determine Amount Realized (i.e. Sales Price)?
· This depends on the transaction and if you sold bitcoins for cash or exchanged them for goods/services.
· In the case of a sale, amount realized is equal to sales price, less any selling costs you incur in the transaction (like commissions or wire transfer fees). So, if you sell a bitcoin for $900 and incur a 1% transaction fee, your amount realized is $900 - $9 = $891.00.
· If you exchanged bitcoins for goods or services (instead of selling them), then amount realized is more complicated. This is essentially a barter transaction, where the default rule is to use the fair market value of the goods or services received in the exchange. For example, if you purchased a laptop on November 29th with bitcoins, your amount realized would be equal to the Fair Market Value of the laptop on that date. The easiest way to determine Fair Market Value is by reference to the sales price, although an alternative method can be used if yields a more accurate value.
· Presumably, the sales price of most goods or services will be denominated in dollars (even though payment is made in bitcoin). Thus, if the laptop's price was $1,500, you can safely assume that its FMV was also $1,500. If the sales price is denominated in bitcoin (instead of dollars), you'll have to convert it into dollars using the average exchange price on that day. As mentioned above, the choice of which exchange to use for this purpose (e.g. Mt. Gox, Bitstamp, etc.) is up to you. The most conservative option would be to use the price from the exchange that you purchased the bitcoin in the first place. Whichever exchange you choose, you should have a reasonable explanation for your choice. You should also stick with that choice when computing your gains in the future. Arbitrarily picking exchange prices that best suit your tax interests will not be acceptable to the IRS in a subsequent audit.
TL; DR:Gain is determined by subtracting basis from amount realized. Basis is generally equal to cost, but special rules must be followed (such as FIFO) if your bitcoins are mixed together. Amount realized is generally equal to sales price. If goods or property were received instead of cash, then amount realized is equal to the FMV of the property received.
Topic 3 Character
#14: Are my gains "capital gains?" Probably. The first hurdle to clear is the classification of bitcoins as a capital asset, because capital gains treatment applies only to capital assets. This is actually a pretty easy hurdle to clear because the definition of a capital asset includes all forms of property by default, unless specifically excluded. So, if you look at the list of excluded property under § 1221(a) of the code, you'll see that bitcoins are not excluded by name, nor would they fall within any of the excluded categories. (keep in mind that this is not true if bitcoins are held as inventory in a trade or business, which might be the case if you mine bitcoins, nor is it true if bitcoins are classified as a self-created intangible asset like a copyright or artistic composition, which is unlikely but possible).
Thus, bitcoins are a capital asset in the hands of most taxpayers and qualify for capital gains treatment. If you were lucky enough to buy your bitcoins more than a year ago, then your gains would qualify for the lower preferential tax rate given to long term capital gains (probably 15%, but it depends on your income level).
If you held you bitcoins for one year or less, then the gains are characterized as short term capital gains, which are taxed at ordinary income tax rates (i.e. the same rate as your paycheck).
#15: What if I mined my bitcoins?
IRS Notice 2014-21 clarified that bitcoin miners have income in the year the bitcoin is mined. The notice is silent as to the character of this income, but it is probably ordinary.
When the miner later sells the bitcoin, the gain is also taxable. The character of that gain is probably capital for the reasons discussed above. However, if your mining activity rises to the level of a "trade or business" and you bitcoins can be considered as "inventory held for sale to customers," than the gain is ordinary income.
Whether your bitcoins are "inventory" depends on the facts and circumstances of your particular situation. Generally, if you sell bitcoins to an exchange, your bitcoins are probably not inventory. If you sell them to a specific person or list of persons/companies, then it's possible they are inventory. I suggest consulting with a competent tax advisor to determine whether your activity is a "trade or business" and whether your bitcoins are "inventory held for sale to customers."