Lauren Assayag – This July, Tesla announced it will likely accept Bitcoin as payment again. If you purchase a Tesla using a cryptocurrency, like Bitcoin, would Tesla recognize the receipt of an asset and record ordinary business income? How would you account for your purchase of the Tesla in exchange for Bitcoin? Would different tax and financial consequences result when Tesla accepts cryptocurrencies when compared to fiat currencies?
The answer is not as straightforward as it may seem. In this example, determining how Tesla should report the transaction and any subsequent conversions, sales, or exchanges of the cryptocurrency depends on whether cryptocurrency is considered a currency or treated as property.
Are cryptocurrencies a type of currency? Some cryptocurrencies, like Bitcoin, act as real-world currencies—as the name suggests—when used to pay for goods and services. However, the I.R.S. does not consider virtual currencies, or cryptocurrencies, to be currencies or cash and cash equivalents, for federal income tax purposes, even if a cryptocurrency is highly liquid. In fact, the I.R.S. has stated that virtual currency is considered to be property.
How do we record the sale? Suppose Tesla receives cryptocurrency as payment for a car. In that case, Tesla must include the cryptocurrency’s fair market value in income, measured on the date that the cryptocurrency is received by converting the cryptocurrency into U.S. dollars at the exchange rate on the date received, provided that supply and demand readily establish the exchange rate of the cryptocurrency at issue. However, if the cryptocurrency received is not traded on any cryptocurrency exchange and does not have a readily determinable value, the cryptocurrency’s fair market value equals that of property or services exchanged.
Upon a sale made with Bitcoin, Tesla would be considered to acquire the cryptocurrency as property at the cryptocurrency’s fair market value at the time of sale. Per I.R.C. § 1222, capital gain or loss generally results when Tesla disposes of its cryptocurrency by exchanging it for U.S. dollars, using it as a means of payment in a future sale, or otherwise.
Moreover, the buyer is considered to have disposed of the cryptocurrency and would record a capital gain or loss, subject to any limitations on the deductibility of capital losses. If the person holds the cryptocurrency for not more than one year before selling or exchanging it, a short-term gain or loss results. If held for more than one year, then the taxpayer may recognize long-term capital gain or loss.
Why does the distinction between property and currency matter? Going back to our example, say Tesla sells a car in exchange for a foreign currency and subsequently converts the foreign currency into U.S. dollars, incurring a substantial foreign exchange loss by the end of the tax year. Tesla could offset ordinary business income with foreign currency losses. However, if Tesla conducts the same transaction in exchange for Bitcoins and subsequently exchanges the Bitcoins into U.S. dollars incurring the same loss, disposing of or exchanging the cryptocurrency may result in a capital loss because the I.R.S. treats convertible cryptocurrencies as property rather than foreign currency. Corporations cannot deduct capital losses in excess of capital gains. Sales may result in higher taxes for a corporation that accepts Bitcoin as consideration for a sale instead of a foreign currency, even if the loss in U.S. dollars is the same upon subsequent conversion because corporations cannot offset capital losses against regular business income.
Given that the substance of the transactions is the same, using cryptocurrencies like Bitcoin should not result in different tax consequences. Some countries have already adopted Bitcoin as legal tender. This year, El Salvador became the first nation to adopt Bitcoin as legal tender. Since 2001, El Salvador has used the U.S. dollar as legal tender and will continue to do so. The use of Bitcoin currently remains optional. The total market cap of Bitcoin alone is estimated to be $960 billion. The major cryptocurrencies are worth well over a trillion dollars.
Moreover, cryptocurrencies are moving into the banking industry. For example, BlockFi is qualified as a lender, with licenses for cryptocurrency deposits in at least 28 states and over 450,000 clients. Bitcoin will probably be subject to future regulations. Given the growing popularity of cryptocurrencies with consumers and businesses like Tesla, the I.R.S. ought to consider resolving the disparity between the substance and form of cryptocurrency transactions.