Last Updated on December 15, 2020
Bitcoin is often described as virtual currency. That’s useful shorthand, but is it really money? And should it be taxed as money if it is? Or is it a capital asset? How about a commodity? Or what about a collectible?
Most commentators view Bitcoin either as a virtual type of currency or capital asset. However, the potential still exists that the IRS can argue that bitcoins do not satisfy the main functions of money. It acts more like a stamp or other collectible than a currency.
IRS Tax Treatment of Bitcoin
In Notice 2014-21, the IRS stated that it plans to tax digital money, such as Bitcoin, like property, not currency. On March 25, 2014, the IRS issued Notice 2014-21, which for the first time set forth the IRS position on the taxation of bitcoins. According to the IRS, “Virtual currency is treated as property for U.S. federal tax purposes,” the notice said. “General tax principles that apply to property transactions apply to transactions using virtual currency.”
By treating bitcoins as property and not currency, the IRS is providing a potential boost to investors. However, it’s also imposing extensive record-keeping rules—and significant taxes—on its use. In a notice, the IRS said that it will treat bitcoin held by investors much like stock or other intangible property. If the investor uses the virtual currency for investment, the IRS will treat it as capital gains. This means they may be subject to lower tax rates.
The top long-term capital gains tax rate is 20%, while the top ordinary income-tax rate is 39.6%. However, the add-on taxes often make both rates somewhat higher. But as capital investments, loss deductions from bitcoin comes with limits. But currency losses can be easier to deduct up front.
IRS Notice 2014-21
The IRS guidance in Notice 2014-21 targets a new crop of digital currencies used by a small number of merchants, consumers and investors. Bitcoin, the best-known of the group, is created using a computer process and can be exchanged for dollars online.
Although IRS Notice 2014-21 did not address whether they will consider Bitcoins an approved investment for retirement purposes, the fact that the Notice is treating bitcoins as property, like stock, and not as a collectible, explains it all. Bitcoin is an approved investment for IRAs and 401(k) plans and will not violate IRC 408(m).
For many retirement investors, the investment in Bitcoin via a Self-Directed IRA LLC or Solo 401(k) plan can be very tax efficient for transacting with bitcoins. Because using bitcoins in a retail transaction typically is a taxable “event” for many buyers. In turn, this requires them to figure out the gain they made on the virtual currency—and eventually pay tax on it. Whereas, the gains will likely not be subject to tax with retirement funds.
Bitcoin Subject to Taxes?
However, the IRS states in the Notice that bitcoin “miners”—including people who use computers to validate bitcoin transactions or maintain transaction ledgers—will also be subject to tax on payments they receive in bitcoin. The IRS also states that any “mining” that possibly constitutes a trade or business is subject to self-employment taxes. Accordingly, dealers in bitcoin—much like dealers in other types of property—will be subject to different tax principles than individual investors. Their gains will be taxed as ordinary income.
Notice 2014-21 is important because it sets forth some clarity by the IRS about the tax treatment of virtual currencies. However it also raises new questions, such as what government body will be in charge of regulation, and the Self-Directed IRA purchases it, how will the currency be held by an IRA custodian?
With IRA Financial Group’s self-directed retirement plans, retirement account investors have the ability to make traditional and alternative asset investments, such as real estate and bitcoins, in a tax-deferred or tax-free basis. Choose the Self-Directed IRA or Solo 401(k) retirement plan for self-employed and small business owners to make Bitcoin investments today.
Whatever platform you decide to use when investing retirement funds into cryptocurrencies, it’s vital that Investors understand the financial risks. Cryptocurrency, such as Litecoin and Bitcoin may have surged since Facebook announced its own cryptocurrency, Libra, to be launched in 2020, the market is still very volatile. Cryptocurrency IRA investors must have the financial ability to bear the risks of a cryptocurrency investment, and a potential total loss of their investment. Cryptocurrency investments, such as Bitcoins, are uncertain and highly volatile. Any retirement account investor who has interest in using retirement funds to invest in cryptocurrencies must do their diligence and proceed with caution.
Did you know?
The IRS treats Bitcoin and other cryptocurrency as property for income tax purposes as per IRS Notice 2014-21.