It is impossible to say at this point whether bitcoins are a foreign currency for purposes of income taxation. No US court has directly addressed this issue, nor has the IRS published any guidance. The closest we’ve come is an obscure federal court decision written by a Magistrate judge involving bank fraud chargers (which has nothing to do with taxation) and a ruling by FinCEN that Bitcoin is not a currency. However, the FinCEN ruling uses an extremely narrow definition of currency that has no application whatsoever to the issue of taxation.
Thus, bitcoin users and tax professionals are left to guess as to its proper classification. When dealing with uncertainties such as this, it is generally advisable to proceed with the most cautious option available until some further guidance is issued by the IRS. In this case, that would be treating bitcoin as a normal capital asset.
However, this is not to say that you would be unreasonable for treating bitcoin as a foreign currency. Indeed, bitcoins are intended to serve as a medium exchange and lack any other functional purpose. Unlike gold, silver or other commodities that have served as currency in the past, bitcoins do not have any industrial or commercial usefulness aside from exchange. This arguably makes them much more similar to a currency than a commodity or other capital asset.
Of course, the fact that bitcoins are not minted by any foreign government or bank casts some doubt as to whether they are truly foreign currency. However, the Internal Revenue Code does not actually employ the term foreign currency. It distinguishes currency as being functional or nonfunctional, and only the US dollar can be a functional currency. Thus, the fact that bitcoin is not produced by a foreign government is not actually relevant, because any currency that is not the US dollar is automatically a non-functional currency and therefore subject to the foreign currency rules. The only question is whether it’s proper to categorize bitcoin as a currency in the first place
In the end, the decision of whether to treat bitcoins as a foreign currency is up to you after consulting with a tax attorney. Just keep in mind that your election could be reversed by the IRS if it subsequently decides that bitcoin is not a foreign currency.