The IRS has decided that Bitcoin is to be treated as property - not currency - for the purposes of taxation.
That's good news for people who are investing in Bitcoin rather than using it to buy things. It means that anyone who buys and holds bitcoins for a year or more will pay capital gains rates of 15% or 20%, depending on income level, as opposed to individual rates, which top out at 39.6%.
But for those who buy bitcoins to spend, the ruling creates significant complications.
People will need to track not just how much they paid for the bitcoins to get their cost basis, but how much the bitcoins were worth when they spent them. The difference is the gain or loss they need to report to the IRS... multiplied by the number of Bitcoin transactions they made over the course of the year.
"People might just be tempted to hoard rather than spend, because as soon as they spend they would be liable to incur capital gains taxes," Pamir Gelenbe, the co-founder of the CoinSummit conference and a partner at venture capital firm Hummingbird Ventures, told The New York Times.
Although keeping track of every Bitcoin transaction sounds like a nightmare, the fact that it's a digital currency also presents a possible solution.
"I can assure you that there are a number of companies that have come up with software to automate this entire process," Barry Silbert, chief executive officer of SecondMarket, told The New York Times.
Indeed, the positive reaction from Bitcoin companies to the IRS announcement suggests that they see opportunity in the new rules.
"Exciting to see clarity from the IRS. Coinbase will help both consumers and merchants to meet the guidelines," the Bitcoin wallet company said in a Twitter message.
Then again, most individuals aren't going to bother tracking every Bitcoin purchase of a latte at their neighborhood coffee shop or clothing at Overstock.com.
The truth is, the IRS has no way of knowing where people spend their bitcoins, unless they make a very large purchase, such as buying an auto from Tesla Motors Inc. (Nasdaq: TSLA). In that sense, people are likely to treat any gains in value from using Bitcoin as a currency as they do modest gambling winnings. They just won't report it.
Miners Won't Like This Bitcoin News, Either
The other members of the Bitcoin community who won't be thrilled by the IRS guidelines are the Bitcoin miners.
The Bitcoin miners use expensive computer rigs to "mine" new bitcoins by solving a complex math problem.
The IRS says that Bitcoin miners must add to their gross income the fair market value of the bitcoins they mine on the day they are generated. That also means they will pay tax on those gains at individual rates, not capital gains rates.
But Bitcoin miners, if they hold the coins they mine, will also have to pay a second tax - this time a capital gains tax - on any gains they have resulting from a subsequent rise in the value of the digital currency.
It gets worse. Any individual who mines Bitcoin as a business will need to treat their profits as self-employment income, which is subject to the self-employment tax (the share of a worker's Social Security and Medicare taxes typically paid by an employer).
"The implications of the new IRS tax guidance will be a major factor for those U.S. miners who didn't anticipate it and are already on the edge of profit. A capital gains tax on all coins mined could drive mining revenue below cost of power for many, forcing them to shut down," Dave Carlson, a U.S. entrepreneur who runs a mining operation, told CoinDesk.
Be Careful What You Wish For
Many Bitcoin enthusiasts had been hoping to get clarity from the IRS to find out how to handle Bitcoin on their taxes, as well as to confer a bit more government legitimacy on the digital currency.
Ironically, because so much of what goes on in the Bitcoin world is not reported or tracked in any way by the government (as are salaries and stock market transactions, for instance), it figures that a lot of taxable activity will go unreported - and there won't be much the IRS can do about it.
Bitcoin really is a new animal in the financial world, and it will take years before the IRS as well as other government regulators truly gets a handle on it. For now, at least the new rules are one more step toward official acceptance of Bitcoin.
"It's getting legitimacy, which it didn't have previously," Ajay Vinze, the associate dean at Arizona State University's business school told The New York Times. "[It] puts Bitcoin on a track to becoming a true financial asset."
The evidence that Bitcoin is becoming more and more mainstream keeps growing. In other Bitcoin news this week, Tera Group said it wants to offer Bitcoin-based derivatives - and it already has two customers lined up for the first multi-million dollar deal...