Next year, in addition to an apparently excellent education, MIT undergrads are each going to get $100 worth of bitcoins to spend. What’s unclear, though, is whether MIT will provide tax advice to go along with those bitcoins.
The MIT Bitcoin Club raised $500,000 to acquire the bitcoins, and is working to get on- and off-campus vendors to accept payment in bitcoin. But, as I’ve discussed in previous posts, even if we envision bitcoins as a medium of exchange rather than a speculative investment (which the MIT Bitcoin Club seems to do), they are not the equivalent of currency for tax purposes. Rather, the IRS treats bitcoins and other cryptocurrencies as property.[fn1]
That means that every time an MIT student “spends” a bitcoin, for tax purposes, there has been an exchange of property, and thus a realization event.
And in English? A realization event means that a something has occurred that triggers tax consequences.
Here, I need to bring up an important piece of tax vocabulary: basis. Basis is, roughly, the amount you pay for something. Basis is important for tax purposes because your taxable gain on the sale or disposition of property is the difference between the amount you get for it and your basis. Say, for example, you bought a share of APPL on January 31, 2014, for $500. Today (May 4, 2014), APPL is trading at $592. Your basis in APPL is $500. If you sell it today, you’ll recognize a gain of $92 (that is, $592 – $500). You’ll be taxed on that $92.
Here, it’s essential to note that you’d be taxed on that $92 even if you sold it for something other than cash. If, for example, you traded your share of APPL for $592 of comic books, that would still be a taxable disposition, and you’d still have $92 of gain to include in your taxable income.
Same thing with bitcoin. As I type this, 1 bitcoin is worth approximately $432. If an MIT undergraduate were to acquire a bitcoin today, she’d have a basis of $432 in it.[fn2] If, in August, that bitcoin is worth $500 and she spend it on books for her MIT classes, she’ll have $68 of taxable gain, notwithstanding the fact that she presumably think of it as an exchange of money, not an exchange of property. Without proper advice, though, she’ll be unaware of the tax consequences of her book purchase, and will fail to pay her taxes on it.[fn3]
And for MIT students, there may be an additional twist, depending on who is providing the bitcoins. If MIT is providing the bitcoins, presumably $100 of a student’s tuition (or activity fees, or whatever) went toward purchasing those bitcoins from MIT, so a student’s basis in her 0.25 bitcoin should be $100.
If, however, the MIT Bitcoin Club is giving the students their bitcoin fragments, it is at least arguably a gift. A gift is not a taxable transaction, but the recipient of a gift of property takes that property with the donor’s basis. Which means that, if the MIT Bitcoin Club buys its bitcoins now, it will have a basis of about $400 in every bitcoin.
If, however, bitcoins are worth $500 in August when it distributes the bitcoins to students, it will only have to give 0.2 bitcoins to every student for the student to have $100 worth of bitcoins. But MIT Bitcoin Club’s basis in 0.2 bitcoins is $80.[fn4] That means that if an undergrad immediately spends her bitcoin for $100 of books, she will have $20 of taxable gain.
I think this MIT bitcoin experiment is terribly interesting. Moreover, if MIT or the MIT Bitcoin Club has though through not just how to develop a bitcoin ecosystem, but how to educate the undergraduate population in the intricacies and potential tax traps of bitcoin transactions, then I applaud their efforts.
If not, though, they have a duty to the MIT undergraduate population to let them know these things.
[fn1] Quite correctly, I should add.
[fn2] Actually, the MIT Bitcoin Club will give her $100 worth of bitcoins, or just under 0.25 bitcoins.
[fn3] Will she be audited? No idea. But, given the publicity of this plan, if I were in the IRS, I’d keep an eye on the tax returns of MIT undergrads. The revenue gains associated with MIT students’ bitcoin transactions wouldn’t be huge, of course, but they’d be relatively easy and inexpensive to find, I suspect.
[fn4] That is, the MIT Bitcoin Club has a basis of $400 in each bitcoin. When it provides 0.2 bitcoins to an undergrad in August at the appreciated value, the basis of that fraction of a bitcoin will be 0.2 x $400 = $80.