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Virtual currencies are a growing phenomenon in the online world. These digital currencies are mostly used to buy and sell virtual property. Some are referred to as “hybrid” currencies, which can actually be used to buy real world goods through an online transaction. One of the most popular of these hybrid currencies is called BitCoin.
BitCoin works as its own currency exchange and because it is not tied to any national currency, the exchange rates can be quite volatile. For example, in its 3 years of existence, BitCoins have been traded for as low as $7 per coin and as high as $260. Thus far, BitCoins are not widely accepted by online merchants but a growing number of Internet retailers that are taking them. So far, BitCoin boasts over a million users.
So how would a virtual currency such as BitCoin affect your tax situation? It would be similar to any other instance where you realized a capital gain inside a currency exchange market. For example, if you purchased 100 BitCoins at $10 per unit, your purchase price was $1000. If the value of the units appreciated to $20 per unit and you either sold them or purchased ‘in kind’ merchandize with them at the increased value, you would have a capital gain of $10 per unit. This gain should be reported to the IRS.
So far, the government has provided very little guidance regarding reporting requirements for online currencies. In addition, it is believed that the Treasury Department does not (as of yet) have an adequate tracking system in place to decipher the profit someone may have made using one of these currencies. However, we all know that eventually the IRS will develop better ways of tracking these transactions at which point they are likely to crack down on those who are not reporting their profits.
As always, it is best to report all your income and capital gains voluntarily instead of waiting for Uncle Sam to come calling. If you are unsure what you should and should not be reporting, speak to a tax expert that can help ensure you pay only the taxes you need to pay, while staying in full compliance with the IRS.