Have you ever thought about using bitcoins to make purchases? If you have, then you may be wondering if there are any benefits or disadvantages for using this popular virtual currency. To understand what those pros and cons might be, let’s use a simple example.
Let’s say that Jane is a consultant who works as a freelancer. She sends an invoice of $1,500 to one of her clients. To pay for the invoice, Jane’s client sends her 1.5 bitcoins. Now, let’s say that the current exchange rate for bitcoins is $1,000 for every bitcoin. Jane decides to use a payment processor that charges her 0.8 percent to use, with a maximum of $8 for every transaction involving bitcoins.
So, Jane has received property that is worth $1,500. This is considered to be ordinary income that she received as part of her trade or business. Thus, it is taxed under the self-employment tax. The $8 transaction fee is added to the capital basis of Jane’s income, so the adjusted basis is $1,508.
Now, let’s say that two years have gone by, and that the bitcoin exchange rate is $2,000. Jane now purchases a computer for $1,000. She uses 0.5 bitcoins for her purchase. What is Jane’s loss or gain on the transaction? To find the answer, we’ll need to take the market value of the property and then subtract Jane’s adjusted basis—in bitcoins, of course.
So, Jane received property that is worth $1,000. In exchange, she used bitcoins that have an adjusted basis of $503. Thus, her taxable gain is $497, and her adjusted basis for the rest of her bitcoins is $1,005. Because Jane held on to her bitcoins for so long, she was able to achieve a long-term capital gain in her favor.
So, what are the pros and cons of using bitcoins? Here are some of the pros:
Your capital losses are deductible.
You can deduct losses on bitcoin transactions from the rest of your income. If you’re a noncorporate taxpayer, you can carry forward losses that you can’t use for the current tax year.
Your capital gains are taxable.
When your bitcoins appreciate, it means that you’re gaining additional income. Thus, you may profit, but you’ll also need to deal with paying taxes on this appreciation, which doesn’t happen with cash transactions.
You’ll have lower transaction fees.
Payment processors such as Stripe often charge lower transaction fees for processing bitcoin transactions than they do for cash transactions. For major purchases, this can translate into significant savings.
And here are some of the cons:
You need to track the adjusted basis.
Since the exchange rate for bitcoins changes, you need to keep track of that and make sure you’re accounting for changes in your adjusted basis. This isn’t the case for cash, of course.
You may have limited ability for transactions.
You can use cash anywhere. Since not everybody uses bitcoins, however, it can be challenging to use them in many circumstances.
Do you have any additional questions about virtual currency? If so, then contact The Royce CPA Firm today at our office in Tucson. We provide dependable accounting services for individuals, families, and businesses.