Bitcoin as Property?

Since we’re all just a little over a week from tax day, I thought I’d share some interesting analysis that was recently published by Nicholas Anthony, a research fellow at Cato Institute’s Center for Monetary and Financial Alternatives. He claims that the rules for capital gains have made it nearly impossible to use Bitcoin as money in the U.S.

Currently, the IRS treats Bitcoin and other virtual currencies as property, not as currency, for federal tax purposes. According to IRS Notice 2014-21, transactions are taxed under general property principles – meaning selling, exchanging,

or using Bitcoin for purchases will trigger gains or losses. Short-term holdings for one year or less are taxed at ordinary income rates, while long-term holdings for more than one year qualify for lower capital gains rates. 

As a result, using Bitcoin creates a tax compliance headache. Anthony explains that every single purchase with Bitcoin requires users to document the purchase date, time of purchase, original cost, as well as gain or loss. All of this information must be reported on IRS Form 8949 and Schedule D to Form 1040. Anthony states that the result is overwhelming. A person who buys a cup of coffee every day with Bitcoin may face more than 100 pages of reporting by the end of the year. Form 8949 alone could be about 70 pages for daily transactions.

“Capital gains tax is structured to provide incentives for long-term holding. This policy creates distortion in the market by motivating buying and selling solely to minimize tax loss. But it is particularly distorting in a currency context, as long-term holding policy counteracts what is normally considered ‘currency use’,” writes Anthony.

Anthony provides several possible ways for Congress to fix this problem. The simplest is to eliminate the capital gains tax entirely on Bitcoin. “Doing so would take the government’s thumb off the scale and let competition be the true decider of the best money,” he writes. A more limited approach is to exempt Bitcoin from capital gains treatment when used as a payment method. However, this would still leave the compliance burden of proving the coins were spent to purchase goods and services. A third option would be the Virtual Currency Tax Fairness Act, which provides a de minimis exception for gains under $200 – but Anthony believes the threshold should be raised to match the average household spending of around $80,000 to better reflect real-world consumption. 

Meanwhile, the payment infrastructure is evolving faster than tax regulations. “It’s never been easier to use Bitcoin for money,” Anthony states. Square recently launched fee-free Bitcoin payments at retail terminals, and self-hosted wallets from Bull Bitcoin, Zeus, and Trezor have simplified consumer payments.

Well, I guess in terms of paying for my next cup of coffee, cash is still king . . .