On May 30, the AICPA Tax Executive Committee (TEC) submitted a letter to the IRS with updated comments (available at www.aicpa.org on Notice 2014-21, the IRS's virtual currency guidance. The comments were prompted by new questions that have emerged about how the tax rules apply to virtual currency transactions since the AICPA first submitted comments on Notice 2014-21 on June 10, 2016. The letter notes that the growing number of types of virtual currencies and their value "make these questions both timely and relevant to a growing number of taxpayers and tax practitioners."
Under the IRS's only guidance on the topic, Notice 2014-21, the IRS treats virtual currencies as property, rather than currency, for federal tax purposes. This means that the general tax principles that apply to property transactions will apply to transactions using virtual currency. In computing gross income, a taxpayer that receives virtual currency as payment for goods or services must include the fair market value (FMV) of the virtual currency (measured in U.S. dollars) as of the date the virtual currency was received.
The letter, from TEC Chair Annette Nellen, covers the following 12 areas and includes 27 suggested FAQs:
- Expenses of obtaining virtual currency;
- Acceptable valuation and documentation;
- Computation of gains and losses;
- Need for a de minimis election;
- Valuation for charitable contribution purposes;
- Virtual currency events;
- Virtual currency held and used by a dealer;
- Traders and dealers of virtual currency;
- Treatment under Sec. 1031;
- Treatment under Sec. 453;
- Holding virtual currency in a retirement account; and
- Foreign reporting requirements for virtual currency.
The TEC notes in the letter that "[v]irtual currency transactions, in which taxpayers increasingly engage, add a new layer of complexity to the analysis of a client's reporting requirements. The issuance of clear guidance in this area will provide confidence and clarity to preparers and taxpayers on application of the tax law to virtual currency transactions."
Mining expenses: The first issue addressed in the letter is the treatment of the expenses of obtaining virtual currency through "mining," which is the process of having computers compete to solve complex mathematical problems. Nellen noted that the process of obtaining virtual currency through mining is akin to a service activity. Therefore, the mining activity is a service activity, and it is appropriate to treat the costs of mining virtual currency similarly, by expensing them as they are paid or incurred. The equipment used for mining virtual currency should be capitalized and depreciated because its useful life extends beyond one year.
Valuation: The second issue is what is an acceptable method for valuing virtual currency and documenting its value. In the original notice, the IRS said that taxpayers could use a "reasonable manner that is consistently applied" to calculate the fair market value of virtual currency. Nellen noted that the value of a virtual currency can vary widely on different exchanges. In response to these varying prices, the AICPA listed six questions and answers about valuation, including a question on whether taxpayers could use an average of the different exchanges to value their virtual currency and a question on whether taxpayers could rely on virtual currency tax software as a reasonable and consistent method for determining fair value.
Gains and losses: The third area of suggested guidance concerns how to compute gains and losses in virtual currency transactions. The letter noted that any time a virtual currency is used to acquire goods or services, it is considered a barter transaction, which may result in gain or loss and may be short-term or long-term. Many taxpayers have difficulty tracing the specific virtual currency used in the transaction. Therefore, the AICPA recommended that taxpayers be able to use either the specific identification method or the first-in, first-out (FIFO) method of valuing their virtual currency, as long as the method chosen is consistently used from year to year.
De minimis rule: The fourth issue concerns an election for taxpayers to make to avoid having to track gains and losses when using virtual currency to make a small purchase, such as buying coffee. The AICPA recommended a de minimis rule for those small transactions, similar to Sec. 988(e), that would exclude small amounts of virtual currency gain or loss for transactions in which the taxpayer recognizes less than $200 of gain.
Virtual currency events: Several of the AICPA's suggested FAQs dealt with issues that have arisen since the release of Notice 2014-21, notably virtual currency events such as chain splits, airdrops, giveaways, token swaps, and staking. The letter contains nine questions and answers recommending positions the IRS should take on the reporting and tax treatment of these various events.