After hearing the idea (on the latest Bitcoin Uncensored podcast, NSFW) of treating the bitcoin as a collectible, it prompted me to compare my past tax experiences regarding the IRS’s treatment of sales of commodities, collectibles, and precious metals that have been held in various ways. I’m not a tax attorney, so below is simply based on my personal experiences and research –YMMV. We already know that the tax code is complex all by itself, and bitcoiners know that bitcoining ain’t easy, so I’d love to hear from the various experts out there on the topic.
Let’s first lay out the tax rules. For most people, income on collectible sales tends be taxed at a higher, fixed capital gains rate (28%) than the income on sales of other investment property, which varies between short term sales (held less than a year): taxed at the individual’s ordinary income bracket rate; and long term sales: taxed at 0%-20%, which is lower than, but relative to, the individual’s ordinary income bracket rate.
Gold and other precious metals are treated by the IRS as collectibles, *even* when held in an ETF, meaning that you still have to pay that 28% rate, even when you don’t hold it physically.
Commodities such as oil and agricultural products *aren’t* deemed to be collectibles, but *can* have their own tax day complications when you invest in them by way of ETFs that don’t actually hold the physical commodities but that, instead, use futures contracts to generate returns.
In these non-collectible, futures-based commodity ETF situations, the tax payer’s relationship to the fund is treated as a limited partnership by the IRS, and gains are taxed as short term gains (whatever your ordinary income is taxed at) no matter how long the individual’s shares are held. If I recall correctly, this situation requires yearly reporting on your taxes based on your fraction of the *partnership’s* sales throughout the year (that is, even if you didn’t sell your own shares), which is no fun to deal with, and you’re generally sitting around later into the new year waiting to receive a Schedule K-1 form in the mail before you can file, even if you didn’t sell any of your own shares.
If I recall correctly, gold-based ETF tax reporting similarly requires a calculation of taxes yearly based on whatever your proportion of the fund’s total physical holdings were sold by the fund managers (often on a monthly basis to cover maintenance of the fund), regardless of what you did with your individual shares, *and* this is taxed at the 28% rate. Once it’s paid, it’s not set it and forget it, though, as you then have to keep track of how this proportional reduction of your holdings impacts your basis for future years — effectively, a reduction of the taxes that you’ll have to pay once you *do*, finally, sell your shares — otherwise you’ll accidentally end up paying more than you’re required!
Based on all of this, how might this apply to bitcoins? Well, there are at least two angles to consider: What might be in the taxpayer’s best interest, and how might we look at the tax classification based on what bitcoins are and how they are used.
My take is that, as a taxpayer, if we’re going to treat bitcoins as some sort of property, I’d rather have the sale of my physically held bitcoins (meaning, those I control the private keys for) treated similarly to the sale of *non-collectible*, physically held commodities/investment property such as oil and agricultural products, rather than treated as collectibles/precious metals. Why? Because, right off the bat, you’re not stuck with paying that 28% rate. Mind you, the government has had its reasons for the higher rate. One explanation that I’ve read is that the buying and selling of collectibles doesn’t have the same benefit to the economy as do other investments, but I’ll leave that discussion for another day.
On to the ETF tax implications, I get the impression that a bitcoin-based ETF (e.g. the to-be-determined Winklevoss’ COIN) would be more complicated for tax purposes than personally holding your bitcoins, *regardless* of how they are classified. Say a bitcoin-based ETF actually holds the private keys (it doesn’t involve any futures), it might still require those yearly proportional sales calculations on whatever fractions of the bitcoin holdings are sold for maintenance of the fund. Actually, thinking about this situation makes me wonder why, or if, this shouldn’t *already* apply to GBTC shares. Any ideas?
So what about the more philosophical angle regarding what bitcoins are and how they are used? Treating bitcoins as non-collectibles may also make sense in this respect, as bitcoins can potentially be thought of as more like an oil or agricultural product, that is, having industrial value (e.g. bitcoins are spent by users of the Bitcoin protocol for the purpose of immutably entering data into the blockchain).
Mind you, oil and agricultural products aren’t re-usable like bitcoins are, as bitcoins don’t have to be burned to realize an industrial value. But is this a difference that matters? Is re-usability the property that requires precious metals to be treated as collectibles, or is it simply their historical use in the numismatic arena that distinguishes them? All re-usable items aren’t collectibles, right? So, what about precious metals that are used for non-collectible, industrial purposes?
This last question makes me wonder what tax implications there are for companies who actually buy *precious metals* explicitly for industrial use (in catalytic converters and electronics, for instance), meaning, not for collectible reasons. Are there any exceptions in the tax code for these cases, or are these companies technically required to pay a 28% rate on any gains in the market price fluctuation of their precious metals, say, between the time their stock of metals is purchased, and their manufactured components are sold?
Is the precious metal value of the manufactured component lost, from a collectible standpoint, once it’s integrated into the product and sold to the market? If so, at what proportion of the total value of the product is this allowable, if that’s even the way to handle it? For instance, I would suspect that a manufacturer of collectible gold bars could be treated differently from a manufacturer of gold-tipped audio-video wiring, but are they treated differently? Might bitcoins *also* be taxed differently, depending on the context that they are being used or sold?
Thinking through all of this seems to have prompted more questions than answers. Feedback would be appreciated.