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The IRS explains that virtual currency is treated as property for Federal income tax purposes and provides examples of how longstanding tax principles applicable to transactions involving property apply to virtual currency. With the rise of virtual currency, many taxpayers wonder what is virtual currency and what impact does it have on their taxes? The IRS has created a list of frequently asked questions to answer this question and more.
Q: What is virtual currency?
A: Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency. The IRS uses the term “virtual currency” in these FAQs to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.
Q: How is virtual currency treated for Federal income tax purposes?
A: Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency.
Q: What is cryptocurrency?
A: Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A transaction involving cryptocurrency that is recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction.