TAXED PROPERTY

What is Bitcoin? It’s a debate that Bitcoiners have agonised over for years, with different viewpoints being proposed as to what digital assets were best suited for. But when the United States Internal Revenue Service (IRS) entered the conversation in 2014, there was only one aspect of digital currency they were interested in: working out how to tax it. Now that Bitcoin had gone mainstream, there was no danger that they were going to let it slip under the radar as an unclassifiable financial asset. The only real question was which bracket they would elect to place it in.

As Bitcoin expanded in both value and use throughout 2013, calls for various U.S. agencies to regulate it had heightened. The pressure on the IRS to provide official guidance came from multiple government bodies – as well as from a tranche of bitcoin holders keen to avoid falling afoul of the notoriously unforgiving tax agency.

In May 2013, the U.S. Government Accountability Office (GAO) set the ball rolling with its report on virtual economies. The report directly addressed the tax implications, concluding that a taxpayer receiving virtual currency as payment for real goods or services could be earning taxable income. Recognizing the widespread confusion, the GAO explicitly recommended that the IRS should “provide information to taxpayers on the tax reporting requirements for virtual currencies.”

Defining Bitcoin

At the heart of the regulatory uncertainty lay a single, fundamental question: for tax purposes, what is Bitcoin? The answer would determine the entire framework for its taxation. Two primary options were debated. The first was to treat Bitcoin as a foreign currency. The second was to treat Bitcoin as property, placing it in the same bracket as stocks, bonds, or real estate.

This second path was attractive to long-term investors, as it would allow them to benefit from lower long-term capital gains tax rates, but posed a significant challenge for anyone using Bitcoin as a medium of exchange. Treating every transaction as a disposition of property would mean that every purchase would be a taxable event requiring the calculation of a capital gain or loss. This would impose an immense record-keeping and calculation burden on users. Despite these challenges, it was this option that the IRS ultimately plumped for.

On March 25, 2014, the IRS published its findings, stating that virtual currency is property, not currency, for tax purposes and outlining the consequences of this classification, such as the taxability of wages paid in bitcoin. This framework created two major compliance burdens. First, taxpayers were required to establish a cost basis for every unit of virtual currency they acquired. Second, for every single transaction, taxpayers had to determine the fair market value (FMV) of the virtual currency in U.S. dollars at the precise date and time of the transaction.

A simple act like buying a cup of coffee with Bitcoin became a complex tax event. The user would have to identify the cost basis of the specific fraction of a bitcoin being spent, determine its fair market value at the moment of purchase, calculate the resulting capital gain or loss, and keep a record of the transaction for tax filing purposes. This level of tracking, unheard of for traditional currency transactions, presented a nearly insurmountable hurdle for the casual use of Bitcoin as a medium of exchange.

The decision to classify Bitcoin as property created a fundamental conflict between the technology's intended purpose and its legal treatment. Bitcoin was conceived as a “peer-to-peer electronic cash system,” designed for frictionless exchange. The IRS ruling, however, forced it to be treated like an investment property, such as a stock, for tax purposes. This heavily disincentivised its use for everyday payments due to the immense record-keeping burden, while simultaneously reinforcing its use case as a speculative investment to be bought and held for long-term appreciation.

The 2014 notice didn’t just interpret the law: it actively shaped the economic behaviour of its users and the evolutionary path of the entire asset class in the United States. And where the U.S. leads, other countries invariably follow. Soon, other nations were rolling out their own crypto tax frameworks. While few have rivalled the United States’ in complexity, they’ve typically taken a similar path in terms of its classification.

Financial author Marc Friedrich believes that “The IRS classifying Bitcoin as property wasn’t about legitimising it — it was an admission they couldn’t stop it. Instead of banning Bitcoin, they tried to fit it into their tax system to maintain control over something fundamentally outside their reach.”

For all its flaws, the IRS’ ruling was a landmark in legitimisation. It signalled that the U.S. government viewed virtual currency not as contraband to be banned, but as a feature of the economic landscape to be regulated and taxed. Bitcoin was many things, but it certainly wasn’t illegal.