If you have been keeping up with new fads, you have probably noticed the growing popularity of the Bitcoin. But, what exactly is a Bitcoin and how does it work?
Bitcoin is a digital currency. Bitcoin can be used to pay for goods or services (if the vendor accepts that type of payment). But, there is no physical currency. Bitcoin is completely electronic, and payments are made and received over the internet using computers, tablets and smartphones.
To get Bitcoin, you visit an exchange on the internet and buy them with real money (US dollars, Euros, etc.). Then you can use your Bitcoin to pay for goods and services from vendors that accept Bitcoin. You can also transfer your Bitcoin to another user. For example, if you and your buddy split a cab and he pays for the ride, you can transfer him Bitcoin to reimburse him for your share.
Sounds pretty neat right? It's like going to the arcade and cashing in dollar bills for game tokens, except the tokens do not physically exist and they can be used all over the world. But, there are a few other considerations that make the concept not so simple.
First, Bitcoin has a market value, similar to an exchange rate. As of the writing of this article, according to bitcoinexchangerate.org, 1 Bitcoin is valued at $653.42. This value will fluctuate according to the demand for Bitcoin, similar to a stock in the S&P 500. This creates an environment where some use Bitcoin to pay for goods and services, while others are holding them as an investment. According to this chart from CoinDesk, the value of a Bitcoin has fluctuated between $67 and $640 in the last year.
Second, the IRS has issued a notice and FAQ's regarding the tax treatment of Bitcoin. In the notice, the IRS states that virtual currency is treated as property similar to other property in the hands of the taxpayer. This means that the exchange of virtual currency for goods and services could result in a gain or loss to the buyer. For example, if I use one Bitcoin I paid $600 for to buy a set of golf clubs for $700, the seller must report the receipt of the Bitcoin as a sale at fair market value on the day of receipt ($700). Also, I must report a $100 gain on the exchange of the currency because I used an asset that cost me $600 to buy something worth $700. Using virtual currency is also subject to the tax reporting rules i.e. 1099's. If I pay a contractor $1,000 in the form of two Bitcoin, I must issue that contractor a 1099 at the end of the year since the value of the services were more than the $600 1099 reporting limit.
In closing, I am a big fan of modern technology and moving into a "greener" world. The use of virtual currency makes it easier for buyers and sellers to transact business across borders without the worry of currency translation. However, users of virtual currency should make themselves familiar with the ins and outs of their transactions and any related tax consequences prior to buying or selling. To find more information about Bitcoin, I found their website very helpful.