Bitcoins are taxed as property rather than currency, the IRS said in late March.
This means that anyone holding bitcoins risks having to pay a tax on gain when the bitcoins are used in the same manner as if the holder sold property and used the cash to buy goods or services. This will make it impractical for individuals and businesses to use bitcoins as currency for ordinary course transactions because of the need to track gains and losses.
The IRS analysis is in Notice 2014-21.
The notice explains the tax treatment of virtual currencies and does not focus solely on bitcoins.
Unsurprisingly, someone being paid in bitcoins must report the fair market value as income, and he takes that value as his “basis” in the bitcoins to measure his gain or loss when he spends the bitcoins later.
A person holding bitcoins as an investment has a capital gain or loss when the bitcoins are sold, unless he is a dealer. Dealers and anyone using bitcoins as a regular currency has ordinary income or loss.
The supply of bitcoins is controlled through a complicated algorithm. The supply increases by 25 bitcoins every 10 minutes currently. Math whizzes using computers race to solve puzzles in order to reap some of the new bitcoins. The race has been described as a cross between a math quiz and a lottery that is held six times an hour. The math whizzes are called “miners.” Anyone receiving bitcoins this way must report the market value of the bitcoins he receives as income.
Bitcoin miners need cheap electricity to run their computers and are moving to places like Minot, North Dakota and Lake Moses, Washington, where the retail rate for electricity is less than 2¢ a KWh compared to a US national average of around 10¢. High electricity prices in places like New York, Tokyo and London mean any miner operating from those cities would lose money.