Fair Market Value – North Carolina Bitcoin Lawyer
Determining the fair market value of cryptocurrency can prove to be a difficult task, especially for the ordinary taxpayer. The IRS Notice 2014-21 which classified virtual currency as property for federal tax purposes, specifically stated that taxpayers must report the fair market value of virtual currency as of the date that the cryptocurrency was received. Although, if you are familiar with the cryptocurrency markets, based on the time for any particular day, the value of virtual currency fluctuates, and sometimes in great amounts.
In property transactions, and even more so in cryptocurrency transactions, the taxpayer should carefully track their basis in the virtual currency. Basis, which is defined as the price the taxpayer paid for an asset, represents a baseline from which gains or losses are calculated. For Example, on January 1, 2018, Jack purchased 3 Bitcoins for $40,800 ($13,600 per each Bitcoin). On March 1, 2018, Jack used 1 bitcoin to purchase $9,000 worth of electronics from an online retailer who accepts payment via cryptocurrency. Jack recognized a loss of $4,600 on the transaction ($9,000 amount realized minus $13,600 basis in one Bitcoin = $4,600 loss). Note that a deduction for losses is only allowed if incurred in a trade or business, or on a transaction entered into for profit. In this example, if Jack was a reseller of the electronics, he could recognize the loss and report it as a deduction. However, if the taxpayer is not holding the cryptocurrency for investment or business purposes, and is simply using cryptocurrency for everyday transactions, a loss may be a nondeductible personal loss. It is for this reason that it is very important that the taxpayer classify their interest in cryptocurrency according to the intended taxpayer’s use.
Depending on each taxpayer’s unique situation, cryptocurrencies, such as Bitcoin, Litecoin, or Ethereum, may be classified as business property, investment property, or personal property. Typically, general tax principles that apply to transactions in property must also be applied to the exchange of a cryptocurrency. Additionally, IRS Notice 2014-21 requires that taxpayers must recognize a gain or loss when exchanging cryptocurrency for other types of property. This means that if a taxpayer uses a cryptocurrency to purchase goods or services, they must recognize a gain or loss in that particular transaction, which in turn must be reported to the IRS.
This presents some interesting scenarios, all of which subject the determination of the fair market value to different interpretations. As a taxpayer, you may choose to use the average price for the day you received the virtual currency, the price at the moment you received the virtual currency, the highest value for the day, or even the lowest value for the day. Often depending on each taxpayer’s unique situation, they will make different choices. For instance, if you were acting as an employer who is paying an employee in virtual currency you may choose the day’s high price, while your employer may choose the day’s lowest price. However, if a 1099 or W-2 has been filed by the employer, the employee will likely be stuck using the same methodology that the employer used in creating the 1099 or W-2. Even the same taxpayer may try using different methods for different transactions, it certainly sounds tempting to go with the higher price in the purchase of cryptocurrency and the lower price in the sale of that cryptocurrency.
Currently, the IRS does not recognize a ‘de minimus’ exception to the gain or loss recognition. This means that taxpayers must keep up with tracking their cryptocurrency basis in an ongoing manner, in order to report the gain or loss recognized on each transaction properly to the IRS. Although this may seem tedious in nature, given the ever-fluctuating values prevalent in cryptocurrency markets, it is far easier to report the gains or losses when they occur, rather than having the IRS auditor determine your basis in the property.
Notice 2014-21 does require that the manner used to determine fair market value must be “consistently applied.” This wording, however, may lead to even more questions. How long must the taxpayer ‘consistently apply’ their methodology? May the method change periodically? How often? Yearly? Semi-Annually? Monthly? Or must the taxpayer use the same method forever? The answers to these questions will ultimately depend on the taxpayer’s needs, the frequency of transactions, the intended use of the cryptocurrency, and the ultimate disposition of it.
