Yes! Losses on bitcoin and other virtual currencies are deductible but be aware that in an audit the IRS can and will disallow any losses that are improperly claimed. And according to IRS Commissioner Chuck Rettig, "The IRS is expanding … efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations" (emphasis added).
This then leaves us with the question as to how should bitcoin losses be properly claimed?
The first thing we need to realize is that despite the label virtual “currency,” virtual currency is not a currency from the IRS’s point of view. Bitcoin and other similar virtual currencies are property, and therefore the general tax principles that apply to property transactions also apply to bitcoin transactions.
If the bitcoin was purchased with “real” currency − that is, a currency issued by a nation’s government − then the amount paid plus any transaction costs represents your “basis” in the bitcoin. “Basis” is a tax term generally meaning how much something cost you in after-tax dollars. If you receive bitcoin in the course of your trade or business in exchange for something you sold or for services you offer, you should include the fair market value (FMV) of the bitcoin on the day you receive it in your taxable income. This value would then represent your basis in the bitcoin. But if the bitcoin received in exchange for goods and services was not included in your income (this would, by the way, be improper), then your basis would be zero. If a person is a bitcoin miner, then the FMV of the bitcoin on the day it is received should be included in taxable income, and that then is the basis in the mined bitcoin.
How a gain or loss from bitcoin is put on your tax return will then be determined by the character of the gain or loss. Since bitcoin is “property,” that character will be determined by whether or not the bitcoin is a capital asset. Generally, property held for investment and the like, such as stocks, bonds, etc., is capital property, while property held for sale to customers in the ordinary course of a trade or business is not capital property.
Put as simply as possible:
- If you have bitcoin that you purchased on an exchange for investment or acquired in the sale of personal-use property, then it is likely a capital asset, in which case it is reported on Form 8949, Sales and other Dispositions of Capital Assets, and is taxed as a capital gain or loss. To determine your gain or loss, subtract your basis from the amount you got for the bitcoin you sold plus any transaction costs.
- If you hold bitcoin as inventory or for sale to customers in the ordinary course of your trade or business, then it is not a capital asset, and any gain or loss will be an ordinary gain or loss.
And please keep in mind that if you cannot substantiate your basis in your bitcoin then the IRS will likely use a basis of zero, so it is very helpful if audited to have complete records of what you paid for your bitcoin, or what the FMV of the bitcoin was on the day it was received.
If you do have dealings in virtual currencies and you receive a letter from the IRS offering their
help or questioning your transactions, and you have TaxAudit membership, please contact us as soon as possible and we will deal with the IRS for you, if needed.