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In our last issue, we discussed the recent I.R.S. guidance on bitcoins which, in general, stated that transactions in bitcoins should be treated as transactions in property under the general rules of the Internal Revenue Code (the “Code”) rather than the special rules applicable to foreign currency. We therefore thought it would be useful to provide a primer on common transactions involving foreign currency (sometimes hereinafter referred to as “FX”) with respect to U.S. individuals.

IN GENERAL

The first thing to note about engaging in transactions involving foreign currency is that foreign currency is treated as any other asset. Think stocks, bonds, or real estate. When an individual buys foreign currency, that individual has a basis in the FX (e.g., Euro) similar to any other investment. When the individual sells that foreign currency, that individual will have a realization event, in which case gain or loss may have to be recognized. Whether the character of that gain or loss is ordinary will depend on the specific transaction and the applicability of Code §988, as will be discussed in more detail below.

Example 1

Mr. FX Guy, a U.S. citizen individual, buys real property located in the U.K. for 100,000 British pounds (£) on January 1, 2014. In order to effectuate the purchase, Mr. FX Guy uses £100,000 that he purchased for $150,000 on January 1, 2012 when the exchange rate was $1.5 to £1. Assume on January 1, 2014, the exchange rate was $2: £1 as the British pound appreciated against the U.S. dollar. The £100,000 has a basis of $150,000. It was acquired on January 1, 2012 and disposed of on January 1, 2014. The disposition is a sale of an asset (in this case, the FX). The amount realized is the fair market value of the consideration received, or $200,000. Accordingly, the taxpayer has a gain of $50,000 attributable to the foreign currency that must be recognized. The character of the gain, and the applicability of §988, will depend on whether the transaction was a “personal transaction.”