Virtual Currency Value

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email: david@myaacg.com
 
David Hahn, CVA, ASA, MAFF, CM&AA, CCIM, MBA

Virtual Currency/ Bitcoin Valuation



Money is typically defined by economists as having three attributes:
it functions as a medium of exchange, a unit of account, and a store of value.

Virtual Currency/ Bitcoin somewhat meets the first of these criteria, because a growing number of merchants, especially in online markets, appear willing to accept it as a form of payment.

Bitcoin lacks additional characteristics that are usually associated with currencies in modern economies. Bitcoin cannot be deposited in a bank, and instead it must be possessed through a system of “digital wallets” that have proved both costly to maintain and vulnerable to predators. No form of insurance has been developed for owners of bitcoin comparable to the deposit insurance relied on by bank customers in most economies. No lenders use bitcoin as the unit of account for standard consumer finance credit, auto loans, and mortgages, and no credit or debit cards have been denominated in bitcoin.


Virtual Currency
A virtual currency is "a digital representation of value that is neither issued by a central bank or public authority nor necessarily attached to a fiat currency, but is used by … persons as a means of exchange and can be transferred, stored or traded electronically".



Tax Treatment of Virtual Currency
IRS Notice 2014-21

SECTION 1. PURPOSE
This notice describes how existing general tax principles apply to transactions using virtual currency. The notice provides this guidance in the form of answers to frequently asked questions.

SECTION 2. BACKGROUND
The Internal Revenue Service (IRS) is aware that “virtual currency” may be used to pay for goods or services, or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency -- i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance -- but it does not have legal tender status in any jurisdiction. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. For a more comprehensive description of convertible virtual currencies to date, see Financial Crimes Enforcement Network (FinCEN) Guidance on the Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (FIN-2013-G001, March 18, 2013).

SECTION 3. SCOPE
In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability. This notice addresses only the U.S. federal tax consequences of transactions in, or transactions that use, convertible virtual currency, and the term “virtual currency” as used in Section 4 refers only to convertible virtual currency. No inference should be drawn with respect to virtual currencies not described in this notice.

SECTION 4. FREQUENTLY ASKED QUESTIONS
Q-1: How is virtual currency treated for federal tax purposes?

A-1: For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.


Q-2: Is virtual currency treated as currency for purposes of determining whether a transaction results in foreign currency gain or loss under U.S. federal tax laws?

A-2: No. Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.


Q-5: How is the fair market value of virtual currency determined?

A-5: For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the
virtual currency into U.S. dollars (or into another real currency which in turn can beconverted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.


Q-6: Does a taxpayer have gain or loss upon an exchange of virtual currency for other property?

A-6: Yes. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. See Publication 544, Sales and Other Dispositions of Assets, for information about the tax treatment of sales and exchanges, such as whether a loss is deductible.




Implications of Virtual Currency is treated as property
The IRS recently decided Bitcoin would be treated as property under US tax law. The IRS defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”  Bitcoin is decentralized, meaning it is not controlled by any government or organization. Rather, Bitcoin was designed so that control of Bitcoin is vested in Bitcoin users all over the world.

Most importantly, the IRS stated that, for tax purposes, virtual currencies are property and not currency.

This means that traditional gain and loss principles will apply; the IRS treats these assets as securities or
business property. A party selling, spending, or otherwise disposing of virtual currency may be subject to
capital gains or ordinary income tax.

Donation Scenarios:
These possibilities lead to three potential tax results for donors of virtual currency. First, a donor giving
virtual currency held short term (ie: less than one year) as a capital asset will be able to deduct the lesser of
cost basis or fair market value up to 50% of adjusted gross income. However, if the donor held the
Bitcoin or other currency for more than a year as a capital asset, the deduction would be the fair market
value of the gift up to 30% of adjusted gross income.  Finally, if the currency is subject to ordinary gain
or loss treatment in the hands of the donor, the donor may deduct the cost basis of the gift up to 50% of her
adjusted gross income.  If Bitcoin was received as ordinary income as payment for services rendered or
property sold, the donor may only deduct the cost basis. The IRS defines the cost basis of the virtual
currency as its fair market value when it was received.

Since the charity will be selling the currency, exempt organizations are not generally taxed on income, even from the sale of appreciated property.



General Asset Scenarios:
Because Bitcoin is property, the IRS will view Bitcoin as either a capital or noncapital asset depending on “the taxpayer’s use of bitcoin or the activity from which he taxpayer earns bitcoin.”  This is significant because the disposition of a capital asset is generally taxed at a lower rate than the disposition of a non-capital asset.

Practically speaking, few taxpayers use and acquire Bitcoin in a manner that would result in the classification of Bitcoin as a non-capital asset. These are limited to Bitcoin miners, dealers, and a few others. Most taxpayers will generate income by disposing of Bitcoin that was purchased or received from a previous holder. Bitcoin
acquired in this manner will be classified as a capital asset. Every disposition of Bitcoin held as a capital asset results in a taxable event. Taxpayers who hold Bitcoin as a capital asset are expected to keep track of their basis in Bitcoin, as well as the Bitcoin’s fair market value on the day and time it was spent, to determine whether a disposition results in a gain or loss.



Fair Market Valuation of Virtual Currency
If a virtual currency is listed on an exchange, and the exchange rate is determined by supply and demand, then the exchange provides observable market transactions by which fair market value can be determined. This analysis of observable market transactions is known as a market approach to valuation. While this seems straightforward in theory, it may not be in practice.  Many virtual currencies, like Bitcoin, are very volatile.

If the entity is an operating business, the virtual currency account likely will not have a material effect on the valuation unless it is deemed an excess asset.  However, for a holding company valuation, the digital virtual currency account may affect discounts for marketability, built-in capital gains taxes, dissimilar blockage.

The uncertainty is translated to the embedded risks such as unknown Trial Experimental Phase, Technology (Block Chain), Volatility, Regulations, and Consumer Protection.












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