# Tax consequences when foreign currency changes in value

As a US taxpayer, if I hold some foreign currency that gains or loses value, what are the tax consequences when I exchange the currency for US dollars or other goods or services?

Let's take a concrete hypothetical example. Suppose in January the exchange rate of pesos to dollars is 10 pesos to the dollar. I take US\$500 and exchange it for 5000 pesos.

1. Suppose in May, the peso has strengthened and the exchange rate is now 8 pesos to the dollar. If I exchange my 5000 pesos for US\$625 at this rate, is my \$125 profit taxable? How do I report it?

2. Suppose that instead of exchanging my pesos for dollars, I use them to buy some goods or services. Say I spend my 5000 pesos on a crate of fine tequila for which the fair market value is US\$625. Do I have a taxable gain, and how do I report it?

3. Suppose instead that the peso weakened and in May the exchange rate was 15 pesos to the dollar. If I exchange my 5000 pesos for US\$333, or goods or services to that value, can I deduct my loss of \$166? How do I report it?

Does the taxability depend on the dollar amounts in question? If so, what are the limits?

If it makes a difference, assume that I held physical currency (rather than a bank account or similar asset), and that I am not in the business of currency trading.

This is somewhat similar to When and how should I pay taxes on ForEx trades?, but that question is specific to Israeli tax law instead of US, and also does not consider the case of exchanging for goods and services.

If you buy foreign currency as an investment, then the gains are ordinary income. The gains are realized when you close the position, and whether you buy something else go back to the original form of investment is of no consequence.

In case #1 you have \$125 income.

In case #2 you have \$125 income.

In case #3 you have \$166 loss.

You report all these items on your Schedule D. Make sure to calculate the tax correctly, since the tax is not capital gains tax but rather ordinary income at marginal rates.

Changes in foreign exchange between a transaction and the conversion of the proceeds to USD are generally not considered as income (i.e.: You sold a property in Mexico, but since the money took a couple of days to clear, the exchange rate changed and you got \$2K more/less than you would based on the exchange rate on the day of the transaction - this is not a taxable income/loss).

This is covered by the IRC Sec. 988. There are additional rules for contracts on foreign currency, TTM rules, etc. Better talk to a licensed tax adviser (EA/CPA licensed in your State) for anything other than trivial.

• Are there different rules if I didn't buy the foreign currency as an investment? (Maybe I just had some left over from an international trip.) If so, how might I demonstrate that it was not intended as an investment? Jan 25, 2015 at 8:34
• @NateEldredge Sec. 988 provides some exceptions, but generally the idea is that if you hold currency for prolong periods of time (>days accidental to some other transaction) - that is investment. Jan 25, 2015 at 9:57
• @littleadv so if the US dollar is being depreciated because of inflation and all other foreign currencies remain the same in value relative to one another and just the US dollar changes in value to those other foreign currencies, then when your convert back to USD you'll have to pay a tax because of depreciation due to inflation that it experienced? Keep in mind in this case, the other currencies didn't go up at all with respect to each other, just in relation to the USD. Basically, you're saying you'll get taxed if you try to protect against inflation. Nov 15, 2021 at 5:17
• @johntrepreneur yes, because you've experienced gain in your operating currency. That's the same as if you've purchased a real estate asset with X dollars, and then sold it for 110% of X after a year, with the inflation being the 10% added. Compared to the purchasing power of your money you gained nothing, but you will still pay tax. Dec 13, 2021 at 2:56