IRS Guidelines on Crypto Transactions Kick Off Fast in 2023

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January 2023 saw the release of two significant Chief Counsel Opinion Memoranda on Cryptocurrency Transaction Reporting. CCA 202302011 explains whether taxpayers can claim a loss deduction for decreases in the value of cryptocurrency. CCA 202302012 discusses the requirements for claiming a deduction for charitable contributions in cryptocurrency.

CCA 202302011: Availability of loss deductions when the value of cryptocurrency declines

In non-taxpayer specific guidance, the IRS determines whether cryptocurrency that declines in value to less than a penny, but continues to trade on an exchange, is considered worthless for the loss deduction rules. IRC Sec. 165. The guidelines signal that the IRS intends to challenge the loss deductions claimed for 2022 for declines in cryptocurrency values.

The relevant facts in the CCA are as follows:

An individual taxpayer purchases a cryptocurrency in 2022 for $1 per unit for investment purposes on a cryptocurrency exchange. At the end of 2022, the value of each unit of cryptocurrency is less than a penny. On December 31, 2022, the cryptocurrency continues to be traded on at least one cryptocurrency exchange. The taxpayer retains dominance and control over the cryptocurrency units, as evidenced by the ability to sell, trade, or transfer the units. The taxpayer claims an IRC Sec. 165 deduction of losses for 2022, taking the position that the cryptocurrency is either worthless or abandoned.

IRCSec. 165 provides a deduction for losses incurred in a tax year which are not offset by insurance or otherwise. A loss is treated as incurred in the year in which the loss occurs, as evidenced by closed and completed transactions and as fixed by identifiable events occurring during the taxable year.[1]

Uselessness

Quoting the Tax Court in Lakewood Assocs. V. Commissioner,[2]the CCA states that “a mere decrease in the value of property does not create a deductible loss”. See also United States v. White Dental Mfg. Co.[3] A loss may, however, be incurred if the cryptocurrency becomes worthless during the tax year. Whether an asset is worthless is a question of fact and requires consideration of both its current liquidation value and the value at which it might be acquired in the future. In a footnote, the IRS observed that as of January 1, 2023, fifteen cryptocurrencies valued at less than one cent per unit were exchange-traded activities.

The CCA concludes that the cryptocurrency had a net asset value at the end of 2022. It continued to be traded on at least one cryptocurrency exchange and it had the possibility of a future increase in value. Therefore, the cryptocurrency was not totally worthless in 2022 and the taxpayer was not entitled to an IRC Sec. 165 deduction of losses.

Abandonment

The CCA also concludes that the taxpayer did not abandon or permanently dispose of their cryptocurrency units in 2022. Abandonment is demonstrated by (1) an intention to abandon ownership and (2) an affirmative act of abandonment , the former not being sufficient to claim a loss. deduction.[4] According to the IRS, the taxpayer did not take steps to permanently surrender the property in 2022. Therefore, the taxpayer was not entitled to an IRC Sec. 165(a) deduction of losses for abandonment.

Miscellaneous Itemized Deductions/Capital Loss

If the taxpayer had sold their cryptocurrency in 2022 at the diminished value to trigger a capital loss, those losses would only offset capital gains, with excess losses capped at $3,000. Excess capital losses will be carried forward to future taxation years. On the other hand, even if the taxpayer had suffered an IRC Sec. 165 loss, no deduction of loss would be allowed. For individual taxpayers, IRC Sec. 67(b)(3) characterizes IRC Sec. 165(a) losses, other than those resulting from accidents, theft and betting, as miscellaneous itemized deductions. IRCSec. 67(g) which was enacted as part of the Tax Cuts and Jobs Act of 2017, prohibits various itemized deductions for tax years from 2018 to 2025.

CCA 202302012: Claiming Deductions for Charitable Cryptocurrency Contributions

In non-taxpayer specific guidance, the IRS determines whether a gift of cryptocurrency over $5,000 requires a qualified appraisal. If a qualified appraisal is required, the IRS also considers whether a reasonable cause exception[5] applies if a taxpayer instead determines the value based on the amount reported by the cryptocurrency exchange on which the cryptocurrency is traded. It is essential to heed this advice, as contribution deductions claimed by those with good charitable intentions may still be disallowed if the substantiation requirements provided by the IRS are not met.

The relevant facts in the CCA are as follows:

An individual taxpayer purchases units of cryptocurrency for personal investment purposes through a transaction on a cryptocurrency exchange. The taxpayer then donates all the cryptocurrency to a qualified charity described in IRC Sec. 170(c). The taxpayer completes Part I, Section B of Form 8283 and attaches it to his return and claims a charitable contribution deduction of $10,000. The deduction claimed is based on a listed value on the cryptocurrency exchange on which the cryptocurrency was traded on the date and time of the donation. The taxpayer did not obtain or attempt to obtain a qualified appraisal for the donation. The taxpayer claims that no appraisal is required because the cryptocurrency had an easily verifiable value based on the amount published by the cryptocurrency exchange.

Qualified assessment required

The CCA concludes that a cryptocurrency donation greater than $5,000 requires a qualified appraisal by a qualified appraiser, among other substantiation requirements. According to the CCA, cryptocurrency is not an easily appraised property exempt from qualified appraisal rules.[6] It is “not cash, a publicly traded security, or any other type of property” listed at Sec. CRI 170[7] and does not meet the definition of a security under IRC Sec. 165(g)(2)[8].

No reasonable cause exception applies

The CCA also considers whether reasonable cause[9] allows a contribution deduction where a taxpayer has determined the value of the donation based on the amount reported by the cryptocurrency exchange. According to the CCA, “the reasonable cause exception was not intended to give taxpayers the choice of whether or not to obtain a qualified appraisal, but to provide relief where an unsuccessful attempt has been made in good faith to comply to the requirements of section 170”. IRS finds claim that cryptocurrency had readily verifiable value because it was listed on a cryptocurrency exchange was not reasonable cause for not obtaining or attempting to obtain a qualified appraisal .

[1] Treasures. Reg. Second. 1.165-1(d)(1).

[2] 109 TC .450, 459 (1997).

[3] 274 US 398, 401 (1927) (providing that Section 165 does not provide for loss deduction for mere fluctuations in property value).

[4] Massey-Ferguson, Inc. v. Commissioner, 59 TC 220, 225 (1972); Treasures. Reg. Second. 1.165-2(a).

[5] IRCSec. 170(f)(11)(A)(ii)(II).

[6] IRCSec. 170(f)(11).

[7] IRCSec. 170(f)(11)(A)(ii)(I) and Treas. Reg. Second. 1.170A-16(d)(2)(i).

[8] IRCSec. 165(g)(2) defines a security as “a share of stock in a corporation; a right to subscribe for or receive a share of shares in a company; or a bond, debenture, note or certificate, or other evidence of indebtedness, issued by a corporation or government or political subdivision thereof, with interest coupons or in registered form. »

[9] IRCSec. 170(f)(11)(A)(ii)(II).

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