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Steptoe Cyberblog

Is the New IRS Rule Good or Bad for Bitcoin?

Posted in Privacy Regulation

Last week the IRS announced that Bitcoin would be treated as property, rather than currency, for tax purposes.  That means the virtual currency will be subject to very real capital gains taxes when used to make purchases.  So is this good or bad for Bitcoin?  Well, that depends on whether you view the glass on Bitcoin as half-empty or half-full.

If your glass is half-empty, you’ll see the rule as creating a practical obstacle to using Bitcoin in everyday transactions that undermines the ease of use that was part of its appeal in the first place.  Under the new rule, if you pay for a product or service with Bitcoins, you’ll have to pay tax on the increase in value from the date you acquired each Bitcoin to the day you spent it.  That’s not an easy thing to keep track of, especially since Bitcoin’s volatility means you may have paid very different prices for your Bitcoins.  That’s sort of like paying for something at a store with individual shares of stock that you may have acquired on different days and at different prices, and trying to select the share that will result in the smallest capital gains.  You may also bristle at the fact that wages paid in Bitcoins are subject to income-tax withholding and that payments of $600 or more made in Bitcoins are subject to IRS reporting requirements, which complicates the anonymity relished by many Bitcoin users.

But if your glass is half-full, you’ll see the IRS rule as a step toward further legitimacy for Bitcoin, a recognition that it’s an increasing presence in our economy as both a medium for transactions and as an asset.  You’ll view increasing certainty regarding the regulatory treatment of Bitcoin as good for its development.  And if you hold Bitcoins for investment, you may even focus on the fact that Bitcoins now will be subject to a lower tax rate than if they were taxed as a currency.

More generally, the IRS rule raises the fundamental Catch-22 of Bitcoin: the more it’s regulated, the more stable it will become, but the more it may drive away those “early adopters” who were drawn to it precisely because it was anonymous and unregulated.  I’ve written more about that issue here.

Warren Buffett recently called Bitcoin a “mirage,” and it’s fair to say that no one ever made money betting against Warren Buffett.  (Speaking of which, Mr. B – is there a prize for getting the fewest number of games correct in the NCAA Tournament?  If so, call me.)  But prominent venture capitalists continue to be bullish on Bitcoin’s future, and more retailers are accepting Bitcoins seemingly every week.

The bet here is that Bitcoin has sufficient momentum that it’s not going away anytime soon.  Especially if some smart app developers figure out how to automate the tax calculation process to offset some of the practical complications for users. But if those app developers get paid in Bitcoins, they should remember to pay their taxes.