How are taxes measured when Bitcoin is exchanged for physical gold and a profit is generated?
If I own Bitcoin and exchange it for physical gold ($24,000) at a jewelry company and I acquired those Bitcoin at a lower price two years ago than today's price, then getting that gold as an exchange and selling it later will generate me some profit. How are taxes measured in this case? Is it capital gain taxes, 28 percent for assets? Also, if I reinvest that money earned by selling that gold after exchanging it, do I still have to pay taxes?
The IRS considers Bitcoin, and all virtual currency, to be property and will tax the gains in the property whenever you sell or exchange your Bitcoin for another asset (including gold or even other virtual currency). So you will have to pay taxes on the amount the Bitcoin has increased in value since you bought it. Below are additional key tax issues related to 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. ” — IRS Notification 2014-21
DETERMINING YOUR TAXABLE GAIN
The tax will be on the gains you realized when you traded the virtual for the Gold. You would also owe a tax if you traded the virtual currency for any other asset or exchanged the currency for a good or service. Basically whenever you ‘dispose’ of the virtual currency, the IRS is going to want it’s cut. You would take the Fair Market Value of the virtual currency and subtract your Basis to determine your gain. And then apply the tax rate to the gain. The tax rate you pay depends on a number of different factors based on your personal situation.
DETERMINING FAIR MARKET VALUE
Fair Market Value can be determined based on the value (in U.S. Dollars) of the virtual currency or the value of the Gold you traded for on the day you made the exchange. As the fair market value for both Gold and Bitcoin bounces around all day long, this may be more difficult than it sounds. Generally, taking the average of the high and the low values on the date of the sale is a reasonable method in the eyes of the iRS.
DETERMINING THE BASIS TO SUBTRACT
Basis is currently a little difficult to ascertain for virtual currencies, but if this is the only virtual currency you own then you can take the price you paid for the Bitcoin when you bought it. The difficulty becomes if you’ve purchased Bitcoin at multiple periods for differing prices, as there is no clear guidance regarding which price to use. The IRS has announced new regulations are forthcoming on determining the basis for Bitcoin, but they may be a few years away. Ideally, you’ll want to work with a professional tax preparer as there is a lot of grey area surrounding calculating the taxation of your Bitcoin gains.
GETTING PROFESSIONAL HELP
If this was the only Bitcoin transaction you’ve had, or if you have a small amount of Bitcoin left, using a Certified Public Accountant to help file your taxes is likely a good idea. The fees you pay in hiring the accountant will likely be offset in tax savings from a more accurate and favorable calculation. And avoiding potential IRS penalties, of course, can save you significantly more.
If you have large amounts of money in Bitcoin, you likely want to work with a fiduciary and fee-only financial planner. Exchanging Bitcoin for Gold at a jewelry company or other retail store likely resulted in you receiving much less than you should have for the Bitcoin. These types of businesses often value the gold at an inflated price much higher than you could immediately turn around and sell it for - and then add on fees to pad their profit even more. A professional adviser can help you minimize tax liability, avoid getting less for the Bitcoin than you deserve, and diversify your investments to include other less risky investments in addition to your Bitcoin holdings. (Although many advisers would try to convince you to get rid of Bitcoin altogether so shop around).