What You Should Know About Virtual Currency
A virtual currency is a form of digital currency that represents monetary value in electronic form. Virtual currencies are not regulated by governments, but they can be exchanged for traditional currencies like the U.S. dollar or euro, held as an investment, or used to purchase goods or services online.
There are several types of virtual currency and new types could be developed in the future. Here are some examples:
Bitcoin and other cryptocurrencies are virtual currencies designed to be used as a medium of exchange over the Internet. The first virtual currency was Bitcoin and was created in 2009 by a pseudonymous entity named Satoshi Nakamoto.
Facebook Credits were a virtual currency used for purchases within social media games on the Facebook platform between 2009 and 2013; Facebook Credits were exchangeable for traditional currencies like the U.S. dollar, pound sterling, and euro.
Linden dollars are the primary currency used in Second Life, an online virtual world that is owned by Linden Lab and inhabited by its registered users through avatars (virtual representations of themselves). Linden dollars can be exchanged for U.S. dollars at various exchange rates that fluctuate with market forces (a current estimate is approximately L$265 = $1 USD; see www.secondlife.
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency—i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the issuing country. However, it does not have legal tender status in any jurisdiction. Virtual currencies are also sometimes exchanged for U.S. dollars or other real or virtual currencies.
In general, the Internal Revenue Service (IRS) applies federal tax laws consistently across all types of currency, including virtual currencies.
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.*
The Financial Industry Regulatory Authority (FINRA) is issuing this alert to warn investors about the risks of virtual currencies, such as “bitcoin.” A virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. Bitcoin has gained media attention recently because of its rapid appreciation in value. It has also raised investor concerns because of its extreme volatility, lack of broad regulatory oversight and vulnerability to theft and hacking.
A number of major companies have announced they will accept payment in bitcoins. However, there are potential risks with virtual currencies, including:
1)Volatility. The value of bitcoin can fluctuate significantly even in one day and has frequently shown significant declines immediately following periods of rapid appreciation.
2)Cybertheft. Bitcoin exchanges have been the subject of cyberattacks that have led to theft or loss by customers. For example, in February 2014, Mt. Gox—one of the original widely used bitcoin exchanges—filed for bankruptcy protection after it said hackers caused it to lose more than 750,000 bitcoins valued at $450 million at the time. Mt. Gox later found 200,000 lost bitcoins. Despite these losses, many other bitcoin exchanges remain in business today.
Virtual currency is a form of online money that holds value only within the virtual world. It can be exchanged for goods and services but does not have any real value.
The IRS has stated that virtual currency is taxable by law just like stocks and other investments. If you receive virtual currency as payment for goods or services, you must include the fair value of the currency in your income for tax purposes. If you exchange one type of virtual currency for another, such as exchanging Bitcoin for Litecoin, you have to report the fair market value of whatever you receive.
If you use virtual currency to pay for goods or services, including wages paid to employees, you have to report those transactions on your tax return. You also have to pay self-employment tax if your use of virtual currency results in self-employment income and your net earnings from self-employment are more than $400.
In addition, if your use of virtual currency results in a gain, you may also have to pay capital gains tax.
Virtual Currency Is Treated Like Property for U.S. Federal Tax Purposes: Virtual Currency Is Treated Like Property for U.S. Federal Tax Purposes provides information on how general federal income tax principles apply to transactions using virtual currency. In some environments,
Virtual currency is a digital representation of value that can be digitally traded and functions as (1) a medium of exchange, and/or (2) a unit of account, and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is not issued or guaranteed by any jurisdiction, and fulfills the above functions only by agreement within the community of users of the virtual currency. Such agreement may be implicit, as with Bitcoin, or explicit, as with Linden Dollars.
The term “virtual currency” refers to a balance or a record stored in a distributed database, in many cases by consensus of a community of users. A “virtual currency system” refers to the software rules governing the database. The term “virtual currency” also refers to the community that uses such systems.
The IRS released guidance on virtual currencies in Notice 2014-21. The agency classifies virtual currencies as property for tax purposes and provides guidance on how general tax principles apply to transactions using virtual currency. Further information can be found at IRS Notice 2014-21: IRB 2014-16 – Virtual Currency Guidance: Virtual Currency is Treated
Because virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, a unit of account, and/or a store of value, virtual currency may be used to pay for goods or services, or held for investment. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency.
Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. For tax purposes, US dollars (or other foreign currency) received from transactions with virtual currency must be reported in U.S. dollars. The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
General tax principles applicable to property transactions apply to transactions using virtual currency. For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency