Ok let's say you paid Mr. Jones $1,000 in cash. Are you using localbitcoins.com?
* if you are being super-conservative, you would get a cash receipt from Mr. Jones for $1,000. But I would recommend keeping a record of the date, person's name (in this case, Mr. Jones), and an accounting entry debiting "Bitcoin Receivable" and crediting "Cash" for $1,000. This is where good bookkeeping comes in which is another service that I offer
Mr. Jones sends 4 BTC to your wallet. So your cost basis for each BTC is $250, what you paid.
scenario (A) accounting entries would be a debit to "Bitcoins" and a credit to "Bitcoin Recievable" for $1,000
scenario (B) as you and I both know, BTC prices change fast ... so if by the time you receive the 4 Bitcoin and the price dropped to $225 then you debit "loss on Bitcoin trades" for $100 and "Bitcoins" for $900 ... then a credit to "Bitcoin Receivable" for $1,000
Smoothie converts the BTC to cash on BTCe at $275 a BTC for a total of $1,100
(A) you would debit "Cash" for $1,100 and credit "gain on Bitcoin trades" for $100 and "Bitcoins" for $1,000
(B) you would debit "Cash" for $1,100 and credit "gain on Bitcoin trades" for $200 and "Bitcoins" for $900
Smoothie sends $1,100 cash to his/her bank account.
in both scenarios, debit to your "bank account" for $1,100 and credit to "cash on BTCe" for $1,100
The documentation that I would recommend is your accounting or bookkeeping entries (if audited explain that obtaining a cash receipt from Mr. Jones was impractical), hard-copies of the transactions on your exchange showing the prices of the BTC when received and converted, and a copy of the deposit to your bank account .... where most people screw up is they only have documentation of the bank deposit and count the entire $1,100 as a gain which is incorrect. You have to keep track of the cost basis of your Bitcoins. In both scenarios above, you only had a $100 gain, not $1,100.
I would strongly argue that "No" you are not a Bitcoin Exchange. Bitcoin Exchanges do thousands of transactions a day. Also, if challenged by IRS, you could argue that you are a Bitcoin investor. The tax and legal rules on Bitcoin are very gray. Lastly, I would advise that you discontinue person-to-person transactions. They are too risky and you might be dealing with an undercover law enforcement agent. Sell and buy on-line using Western Union on LocalBitcoins.com
Hope that this helps. If you have more questions, call me at 410-209-9365.
