In our previous post we discussed the murky legal standing of the virtual currency bitcoin, which is still in the early stages of adoption by tech-savvy investors. Tax law experts had been awaiting guidance from the Internal Revenue Service about how to categorize bitcoin holdings for tax purposes. As we discussed previously, one option was to consider bitcoins to be a foreign currency and another was to categorize it as a capital asset.

The new guidance from the IRS clears this issue up, saying definitively that taxpayers should categorize bitcoins as property. The virtual currency should not be taxed as foreign currency, the IRS says, because although it can be exchanged for goods, no sovereign nation accepts it as legal tender.

By considering bitcoins as property, all of the normal taxation principles that apply to other types of property will apply. For example, if a business accepts bitcoins in exchange for goods or services, the value of the bitcoins measured in U.S. dollars on the day of the transaction will be considered a part of their gross income.

If someone is holding bitcoins as an investment then they will be subject to capital gains taxes, as previously surmised by some experts.

Bitcoins are generated through the use of special “mining” software. People who mine bitcoins must declare the value of those new bitcoins as a part of their gross income and must pay self-employment taxes as well if they are mining bitcoins as a business.

This guidance adds a lot of clarity to the situation for bitcoin users, although new situations will certainly arise that require additional clarifications.

Source: USA Today, “IRS: Bitcoin is not currency,” Donna Leinwand Leger, March 25, 2014.