Happy April, 15th! For U.S. citizens and residents, today is tax day. And if you're one of the many Americans who was pulled into the cryptocurrency fray last year—if you traded Bitcoin on online exchanges, if you bought a ticket to space with bitcoins, even if you just used it to buy your morning coffee—then filing your taxes just got a lot more complicated. Last month, the U.S. Internal Revenue Service (IRS) published its guidance for “virtual currency” holders, in which it defines Bitcoin and all other digital currencies as property rather than foreign currency. In order to comply with the rule, Bitcoin holders who are U.S. taxpayers must now calculate a capital gain or loss on every transaction they make. If you bought your Bitcoin at US $600, but it was valued at $800 when you used it to buy that coffee, then you owe taxes on the difference.
With Bitcoin's crazy price swings—the exchange rate of Bitcoin soared past $1000 last December, went down to $800 in February, and it's around $500 today—that makes for a lot of messy calculations. Fortunately, the Bitcoin community doesn't tend to sit on its problems for very long, at least not when they are technical in nature. Companies are already emerging to offer simple, automated tax preparation for Bitcoin users. This will be the primary product of a company called LibraTax, which plans to officially launch this fall.
“There's really no comparable service out there that accomplishes this yet,” says Jake Benson, the CEO of LibraTax. “The first product will launch at the latest in the September time frame. That's just in time for extended tax season, which is October 15th.” (The IRS allows tax payers to get a six-month extension on filing taxes.)
It should be noted that Bitcoin itself already facilitates good record keeping. Every transaction processed by the Bitcoin network is recorded in a public ledger called the blockchain that is searchable by anyone who cares to download it. You could calculate your own gains and losses by finding your addresses on the blockchain, marking each time a Bitcoin moved into or out of those addresses, and referencing the market price of Bitcoin for each transaction. All the information is there. But this is probably not feasible for someone who uses Bitcoin to buy their coffee every morning. “The problem is it's very hard to track the cost basis at such a frequency, especially doing it by hand. So, even CPAs that are experienced with tax procedures are going to have difficulty this year figuring out what people owe,” says Benson. Cost basis refers to the original amount paid for a property with an adjustment for any fees that were rolled into the amount (such as a commission on currency trades).
Instead, LibraTax will offer to do all of it for you. Just tell them what Bitcoin addresses you control and their algorithm will scrape the blockchain and send you back a calculation of your gains or losses. If you are attempting to remain anonymous on the Bitcoin network, and you do not like the idea of a tax company being able to link your name with an address on the blockchain, Benson says you can still use the service. In this case, he recommends downloading a history of your transactions and sending it in a spreadsheet. (Although it still seems like it would be possible to run an algorithm that scans the Bitcoin blockchain and matches your transactional history with an address. At some level you are going to be compromising your privacy in order to use a service like this.)
Benson hopes that companies like LibraTax (and another called BitcoinTaxes, which calculates capital gains from online currency exchanges, but not from every day purchases) will quell anxiety within the Bitcoin community. In the days following the IRS announcement, the exchange rate of Bitcoin fell more than $100. To be fair, there are several factors probably contributing to the recent decline. People blame China for causing a speculation bubble which seems to have subsequently popped after banks were barred from doing business in Bitcoin. People blame the media for burning out users with Bitcoin hype. But there is a sense that the IRS came along and made everything much more difficult than it had to be and that the future would look much brighter if Bitcoin were considered a foreign currency.
“There are multiple things going on, but I think [the IRS ruling] does play into it,” says Benson. However, he considers the guidelines to be the best possible outcome. “Treating Bitcoin as a property is really the easiest way to deal with the transactions, and the most financially beneficial as well,” says Benson. “I'm actually quite optimistic about the guidance because the other option was taxing Bitcoin as a currency. The bottom line is, the tax rate for profits and capital gain is less than gains you make on a foreign currency. That's almost the best tax treatment you could ask for,” he says.
Moreover, not everyone will be paying taxes on gains. A lot of people will be claiming losses instead. According to Benson, any individual can claim up to $3000 in losses. The ability to do so may actually make Bitcoin more attractive as an investment tool.
“If you lost buying power with Bitcoin, you can actually file a loss with that. That's a benefit I think not enough people are paying attention to,” says Benson.
*Two corrections were made to the original version of this article on April 15, 2014. Jake Benson is the CEO of LibraTax, not the COO. In addition, he was misquoted as referring to tracking costs. His correct words were “cost basis.”