Tax strategies for virtual currency.

• Author: Young, Patrick L.

This case study has been adapted from PPC's Guide to Tax Planning for High Income Individuals, 20th edition (March 2019), by Anthony J. DeChellis and Patrick L. Young. Published by Thomson Reuters, Carrol I ton, Texas, 2019 (800-431-9025; tax.thomsonreuters.com).

Virtual currency (also known as cryptocurrency), such as bitcoin, has been increasing in popularity. Virtual currency may be used to pay for goods or services or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like "real" currency, but it does not have legal tender status in any jurisdiction.

Observation: Bitcoin futures can now be traded on futures exchanges. Guidance is provided by the Commodity Futures Trading Commission.

For federal tax purposes, virtual currency is treated as property (Notice 2014-21). As such, it can be classified as business property, investment property, or personal property. General tax principles for property transactions apply to transactions using virtual currency. The IRS recently issued a revenue ruling (Rev. Rul. 2019-24) and posted FAQs on its website (available at tinyurl.com/uy78bp4) providing additional guidance on the tax treatment of virtual currency transactions.

Basis in virtual currency is the fair market value (FMV) of the currency on the date the currency is received. If received as payment for services, it is considered taxable income and will be subject to both income and Social Security taxes.

Using the virtual currency to obtain cash or purchase goods is a recognizable transaction. If the FMV of property received for the virtual currency exceeds the taxpayer's adjusted basis in the currency, the taxpayer has a taxable gain. A loss will occur if the FMV is less than the taxpayer's basis. The character of the gain or loss depends on whether the virtual currency is a capital asset for that particular taxpayer.

IRS enforcement efforts

The IRS is attempting to crack down on unreported income from virtual currency transactions. Starting with the 2019 Form 1040, Schedule 1, Additional Income and Adjustments to Income, the IRS is asking taxpayers for the first time if they had a financial interest in any virtual currency during the tax year. The IRS's FAQs remind taxpayers that they must report income, gain, or loss from virtual currency transactions on their federal income tax return for the tax year...