There was an interesting conversation in the chat room earlier today regarding how currency exchange is taxes. I began some research tonight and will post some articles that I've found that seems to address the subject. I have no idea what the IRS will rule, but there is some interesting reading to be had on the subject.
An Introduction to Currency Taxation
Posted by IWC on September 28, 2012
A basic understanding of currency exchange principles is critical for U.S. expatriates, international business people, and global investors.
U.S. tax liability is determined in U.S. dollars. Because currency values change relative to one another, many tax issues arise when currencies are bought and sold. Last month, we discussed general factors affecting relative currency values and currency exchange rates. This month we will look at general questions of currency exchange taxation:
- If foreign currency is purchased and the value of that currency goes up prior to sale (you get more dollars back than you started with), is that gain taxed as a capital gain or as ordinary income?
- If foreign earned income is exchanged for dollars (no gain on invested capital), how is that taxed? And, what if foreign earned-income is never exchanged for dollars, how is tax computed in that case?
[b style="padding: 0px; margin: 0px;"]Gain on Sale of Currency: Ordinary Income[/b]
Long-term capital gains income is usually taxed at a lower rate than ordinary income (which is taxed at an individual’s marginal tax rate). When foreign currency is purchased and later disposed of, as an investment or as a hedge, the gain or loss on the disposition (sale) of that foreign currency will be taxed as ordinary income. This is distinct from the purchase and later sale of other investment assets, which typically get capital gains treatment. The reason for ordinary income treatment of currency transactions is that Congress views currency fluctuations as tied to interest rate changes. Thus, the fluctuations are taxed as if they were interest earned, as ordinary income.
[b style="padding: 0px; margin: 0px;"]Personal Currency Transactions[/b]
Personal currency transactions (those not for business or investment purposes, as for a vacation) receive distinct tax treatment. Currency gains or losses less than $200 are de minimis and have no tax effect. If the gain is higher, then it is taxable as a capital gain (not as ordinary income, as above). Losses on currency exchanges from non-profit-seeking endeavors are normally not deductible. Similarly, a currency gain on the sale of a personal residence (sold in foreign currency) in a foreign country is taxable, but a currency loss on the repayment of the mortgage would not be deductible.
Last edited by Bama Diva on Tue 02 Jul 2013, 9:24 pm; edited 1 time in total (Reason for editing : added info)