Cryptocurrency Taxes: Beware Of Crypto Losses And The IRS’s Position – Fin Tech – United

Following the demise of the cryptocurrency exchange platform
FTX, many taxpayers are studying how they can harvest tax
losses associated with their devalued crypto assets. To better
assess those options, taxpayers should be mindful of the IRS’s
position for the tax provisions relating to losses in a January
10^th Chief Counsel Advice (CCA). The CCA concluded that
a taxpayer who owns cryptocurrencies that substantially declined in
value may not deduct those losses on the basis that (i) the crypto
asset is worthless or (ii) abandoned, in addition to a larger
limitation that the deduction would be disallowed under the
miscellaneous itemized deductions between the years 2018 through
and including 2025.¹

Very generally, losses are deductible if they are
“sustained during the taxable year” and are
“evidenced by closed and complete transactions, fixed by
identifiable events.”² According to the CCA, a
decline in the value of the cryptocurrency does not in and of
itself qualify for a tax deduction; the taxpayer must dispose of
the asset and relinquish control and dominion, either via sale or
total abandonment. However, if a cryptocurrency is determined to be
worthless and is no longer saleable, it may rise to an
“identifiable event” that would allow a tax deduction.
Whether an asset is “worthless” turns on facts and
circumstances. A tax deduction based on “abandonment” of
the property turns on proving whether the taxpayer has (i) shown an
intention to abandon the property and (ii) has taken an affirmative
act of abandonment. Intention alone does not suffice; the taxpayer
must show an affirmative act. In the facts set out in the CCA, the
taxpayer did not demonstrate the abandonment of the cryptocurrency.
Even though the cryptocurrency was valued at less than a cent, the
taxpayer continued to own it (ergo, did not sell or swap it for
another coin). Additionally, the taxpayer never demonstrated an
intention coupled with an affirmative action to abandon the
cryptocurrency, thereby failing to meet the requirement of
abandonment for the loss to be allowed. ³

Consider the following example. On Day A, Justin purchases X
Coin at $100 on Y Exchange. On Day Z, X Coin drops in value to $1.
Justin is very upset that his investment went sour. He leaves X
Coin on Y Exchange at its current value of $1 and proceeds to file
his income tax return for the relevant year, taking a loss-at-cost
basis on his return ($99). Justin will likely have to revise the
return upon an IRS audit because he neither (i) relinquished
control nor (ii) abandoned his property (X Coin). Furthermore, X
Coin continues to be available on Y Exchange, albeit at a much
lower price point (ergo, $1), thereby losing the argument that X
Coin is now worthless.

The importance of the CCA is to remind taxpayers that the IRS is
paying close attention to taxpayer return positions, specifically
as it relates to crypto losses, and to be mindful of potentially
aggressive positions that are likely to be second-guessed.

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Footnotes

1. ILM 202302011

2. Treas. Reg. Section
1.165-1(d)(1)

3. I.R.C. §165

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.