Carsten converted $1,000 into Bitcoin in November 2020. In October 2021, when the value of his holding had increased to $2,500, Carsten decided to purchase a watch using Bitcoin. He spent the entire holding on the watch. How will Carsten report this on his tax return?

No reporting is necessary until he sells the watch. At that time, he will report a gain or loss, depending on the sale price of the watch.

As a short-term capital gain of $1,000 on Form 8949. His basis in the watch is $2,500.

As $2,500 in ordinary income.

No reporting is necessary when purchases are made using virtual currency.