Measuring the Fair Market Value of Assets in Bitcoin

April 25, 2014

We have previously commented  on the IRS’ decision to categorize Bitcoin as property. In light of the ways people use Bitcoin, the regulations look increasingly unsuitable. Now, when taxpayers make purchases they must calculate their capital gains liability just as they do when they sell stocks. Bitcoin users must also estimate the 'fair market value'  of both their Bitcoins and the products they have bought. A difficult process to compute for most, which may be impossible for assets only valued in Bitcoin.

To work out their capital gains or losses, taxpayers have to determine the net difference from acquisition to sale. The listed exchange rates will show the price of Bitcoin in dollars at any point in time. However, as some products are cheaper to buy with Bitcoins than dollars, their fair market value will be more than the exchange rate represents. As far as the IRS is concerned, this qualifies as a capital gain.

It’s no secret that Bitcoins are used on websites like Silk Road to purchase illicit items and the IRS wants to tax these consumers. Bitcoins will buy about a third more Ecstasy on the online marketplace than dollars could get you on the street. In this scenario taxpayers will have to pay for the capital gains of the extra products that Bitcoins bought them. Stranger still, drugs that sell for less in Bitcoin than dollars are to be considered a tax deductible capital loss.

Of course there are varying prices in Bitcoin for all kinds of goods, not just the illegal ones. Even owners of certain legitimate Bitcoin assets could find themselves surprised by a large outstanding tax bill. If their assets were valued only in Bitcoin terms, it is a hard task to measure their fair market value in dollars.

This type of asset is a reality. Havelock Investments is an investment fund that trades exclusively in Bitcoin. Its funds are sold in Bitcoin and it pays dividends in it. The funds available through Havelock Investments are not listed elsewhere and cannot be purchased in dollars. For taxpayers to assess their tax liability, they have to track not only the value of their Bitcoins against the US dollar, but also if this price is a fair representation of their asset’s value. This is one more example of unrealistic expectations for the Bitcoin-using taxpayer and it’s yet another reason to think that the IRS ruling was misguided.

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