Spent bitcoins? Expect a tax headache

I lived on bitcoin for 24 hours
I lived on bitcoin for 24 hours

Did you experiment with the digital currency Bitcoin last year? Get ready for some funky tax math.

This upcoming tax season will be the first time many Bitcoin users take a crack paying taxes on their digital currency purchases. It was only last year that Bitcoin got popular enough that Overstock.com, Microsoft and others started accepting it as a payment method.

The IRS said in 2014 that Bitcoin is a property, not a currency. So, prepare to carefully pore over every single item you bought last year with bitcoins.

First, the basic rule: The government views Bitcoin kind of like company stock. If it increases in value and you sell it, you experience a "gain" -- like a capital gain -- and must report it as income.

Now for reality: The value of a bitcoin steadily slid last year by 58%. It started the year at $748 per bitcoin and ended at $317. It performed worse than the Russian ruble. So you likely didn't experience any gains, and you don't owe taxes.

The example

Let's say you're the average person who dipped toes into Bitcoin, maybe buying a single bitcoin and spending some of it on a few items throughout the year.

You'll have to compare the value of the original bitcoin with the value of the portion you spent.

For example, let's say you bought 0.1 BTC for $60 in July and the value fell to half in October. That's when you spent it at a high-tech bar. That portion was then worth $30. You experienced a $30 loss.

Now repeat that over and over again.

The headache

This gets wildly confusing if you acquired Bitcoin several times, explained New York tax lawyer Tyler S. Robbins. If you just kept adding bitcoins to your wallet, it's like pouring water into a glass. How do you determine an "original value?" You can't. They're all mixed in together.

"This is extremely burdensome -- a lot of headache for ridiculously small dollar amounts," said Omri Y. Marian, who teaches law at the University of Florida.

Ironically, it'll be worst for those who used Bitcoin most trivially. The accounting is actually easier for those who bought large amounts as a risky investment and sold it in a few, large chunks.

Some accountants say Bitcoin users can claim the drop in the digital currency's value as a capital loss up to $3,000. This lowers your overall income, shrinking how much you owe in taxes.

Luckily, Bitcoin keeps a perfect, public record of transactions. And most Bitcoin wallet software programs, like Blockchain.info, offer simple ways to export your data into a spreadsheet.

There's even an automated Bitcoin calculator, called LibraTax, that's free as long as you're counting 500 or fewer transactions. You just plug in your wallet IDs. It took me only 10 minutes calculate my 2014 bitcoin purchases.

In the rare case you did experience a gain and owe taxes, your accountant will probably charge you an extra $25 to $100 for that one line item, according to W. Hunter Robinson, an accountant in Memphis, Tenn. You'll have to use an additional tax form, called an 8949.

This is why many people thought the IRS made a mistake by not classifying Bitcoin as a currency. If it did, that would let you ignore most price fluctuations, similar to spending euros or yen while on vacation.

In the end, most people are likely to just ignore these rules and not report a thing, according to Steve Rosenthal, a senior fellow at the Urban Institute.

"The rules are too complicated, and they result in a bizarre answer," he said.

Jose Pagliery is the author of Bitcoin - And the Future of Money (Triumph Books, Chicago).

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