By Kevin Drawbaugh and Patrick Temple-West
WASHINGTON (Reuters) - Wading into a murky tax question for the digital age, the U.S. Internal Revenue Service said on Tuesday that bitcoins and other virtual currencies are to be treated, for tax purposes, as property and not as currency.
"General tax principles that apply to property transactions apply to transactions using virtual currency," the IRS said in a statement, meaning that bitcoins would be taxed as ordinary income or as assets subject to capital gains taxes, depending on the circumstance.
Bitcoin, the best-known virtual currency, started circulating in 2009. Its present market value is around $8 billion, with up to 80,000 transactions occurring daily, according to accounting firm PricewaterhouseCoopers LLP.
Recent incidents have brought the currency under new regulatory scrutiny, such as the failure of Mt. Gox, a Tokyo-based exchange that filed for bankruptcy after losing an estimated $650 million worth of customer bitcoins.
Unlike conventional money, bitcoin is generated by computers and is independent of control or backing by any government or central bank, which its proponents like, but which also has led to calls for more guidance on U.S. tax treatment.
The IRS supplied that in its statement, which dealt a blow to bitcoin "miners," who unlock new bitcoins online. The IRS said miners must include the fair market value of the virtual currency as gross income on the date of receipt.
This change "is a disincentive to start looking for bitcoins," said John Barrie, a partner with law firm Bryan Cave LLP, who advises charities that receive bitcoins as donations.
NOT LEGAL TENDER
The IRS also said that virtual currency is not to be treated as legal-tender currency to determine if a transaction causes a foreign currency gain or loss under U.S. tax law.
For other forms of gains or losses involving virtual currency, the IRS explained how to determine the U.S. dollar value of virtual currency and said taxable gains or losses can be incurred in related property transactions.
"The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer," the IRS said.
If a taxpayer holds virtual currency as capital - like stocks or bonds or other investment property - gains or losses are realized as capital gains or losses, the agency said.
However, when virtual currency is held as inventory or other property mainly for sale to customers in a trade or business, ordinary gains or losses are generally incurred, the IRS said.
Capital gains and losses are taxable and deductible at different rates and amounts than ordinary gains and losses.
Democratic Senator Tom Carper, who chaired a Senate committee hearing last year on bitcoin, said in a statement that the IRS guidance "provides clarity for taxpayers who want to ensure that they're doing the right thing and playing by the rules when utilizing bitcoin and other digital currencies."
New bitcoins come from a process called mining. Computer programmers around the world compete to crack an automatically generated code and the first to do so is rewarded with a small stash. This happens about every 10 minutes.
Some online retailers will accept bitcoins as payment. The maximum potential number of bitcoins in circulation is 21 million, compared with around 12 million currently.
On the IRS guidance, William Lewis, a lawyer in Sunnyvale, California, who represents a start-up company creating a platform for virtual currencies, said: "This is going to be unfavorable to bitcoin miners because they're going to have to include in income the fair market value of the virtual currency on the date they mined it.
"It's going to make life difficult for a lot of people who have been mining over the past year, who have to go back and see what the values were on those dates when they mined it."
(Additional reporting by Douwe Miedema; Editing by Steve Orlofsky)