In a latest Chief Council Advisory, the IRS discovered that sure cryptocurrencies didn’t qualify as like-kind exchanges beneath part 1031 previous to the Tax Cuts & Jobs Act of 2017. The IRS’s ruling, whereas restricted to coin exchanges involving Bitcoin, Ether, or Litecoin, supplies perception on the IRS’s present considering on the topic.
The ruling introduced the next acknowledged query: If accomplished previous to January 1, 2018, does an change of (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin, or (iii) Ether for Litecoin qualify as a like-kind change beneath § 1031 of the Code?
The ruling set forth the next conclusion: No. If accomplished previous to January 1, 2018, an change of (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin, or (iii) Ether for Litecoin doesn’t qualify as a like-kind change beneath § 1031 of the Code.
Background on Digital Foreign money
The IRS defines “virtual currency” as a digital illustration of worth that capabilities as a medium of change, a unit of account, or a retailer of worth apart from a illustration of the U.S. greenback or a overseas foreign money. Discover 2014-21; Rev. Rul. 2019-24. Virtual currency that has an equal worth in actual foreign money, or acts as an alternative to actual foreign money, akin to Bitcoin, is known as “convertible” digital foreign money and is considered property for federal income tax purposes. Discover 2014-21.
Bitcoin, Ether, and Litecoin are all types of cryptocurrency, a subset of digital foreign money that makes use of cryptography to safe transactions which can be digitally recorded on a distributed ledger, akin to a blockchain. Rev. Rul. 2019-24 at 2. Distributed ledger expertise makes use of unbiased digital techniques to report, share, and synchronize transactions. Cryptocurrencies could also be used as a technique of fee or for funding or different functions.
Cryptocurrency exchanges are digital platforms that permit customers to commerce one cryptocurrency for an additional cryptocurrency, in addition to for fiat currencies such because the U.S. greenback. Main cryptocurrencies like Bitcoin and Ether sometimes could also be traded for another cryptocurrency and vice versa. Nonetheless, some cryptocurrencies on a cryptocurrency change might be traded for less than a restricted variety of different cryptocurrencies and can’t be traded for fiat foreign money in any respect. In 2017, there have been greater than 1,000 completely different cryptocurrencies in existence.
Part 1031(a)(1) of the Code supplies that no acquire or loss shall be acknowledged on the change of property held for productive use in a commerce or enterprise or for funding if such property is exchanged solely for property of like-kind which is to be held both for productive use in a commerce or enterprise or for funding. The nonrecognition of acquire or loss beneath § 1031 is meant to use to transactions the place the taxpayer’s financial scenario following the change is basically the identical because it had been earlier than the transaction. H. Rept. 704, 73d Cong., second Sess. (1934), 1939-1 C.B. (Half 2) 554, 564. The Tax Cuts and Jobs Act, P.L. 115-97, amended § 1031 to restrict like-kind change remedy after December 31, 2017, to exchanges of actual property. Previous to 2018, part 1031 additionally utilized to sure exchanges of private property.
Treas. Reg. § 1.1031(a)-1(b) defines “like variety” to imply the character or character of the property and never the grade or high quality. One variety or class of property is probably not exchanged for property of a distinct variety or class. For instance, an investor who exchanged gold bullion for silver bullion was required to acknowledge acquire partly as a result of silver is primarily used as an industrial commodity whereas gold is primarily used as an funding. Rev. Rul. 82-166. Equally, an investor who exchanged one type of gold coin for an additional type of gold coin was required to acknowledge a acquire as a result of one coin’s worth was derived from its collectability whereas the opposite’s worth was derived from its metallic content material. Rev. Rul. 79-143.
The IRS’s Rationale:
The IRS set out the next evaluation with respect to the cryptocurrencies at challenge within the ruling. To make sure that the reader get the first-hand account of the IRS’s present considering on the topic, we are going to set out the related evaluation from the ruling under:
BTC/LTC and ETH/LTC
In 2016 and 2017, Bitcoin, and to a lesser extent Ether, held a particular place throughout the cryptocurrency market as a result of the overwhelming majority of cryptocurrency-to-fiat buying and selling pairs provided by cryptocurrency exchanges had both Bitcoin or Ether as a part of the pair. In different phrases, a person searching for to put money into a cryptocurrency apart from Bitcoin or Ether, akin to Litecoin, would usually want to accumulate both Bitcoin or Ether first. Equally, a person searching for to liquidate his or her holdings in a cryptocurrency apart from Bitcoin or Ether, akin to Litecoin, usually would want to change these holdings for Bitcoin or Ether first. In distinction, Litecoin’s buying and selling pair availability on the time was considerably extra restricted.
Thus, Bitcoin and Ether performed a basically completely different function from different cryptocurrencies throughout the broader cryptocurrency market throughout 2016 and 2017. In contrast to different cryptocurrencies, Bitcoin and Ether acted as an on and off-ramp for investments and transactions in different cryptocurrencies. Due to this distinction, Bitcoin and Ether every differed in each nature and character from Litecoin. Subsequently, Bitcoin and Litecoin (BTC/LTC) don’t qualify as like-kind property for functions of part 1031; nor do Ether and Litecoin (ETH/LTC).
As mentioned above, Bitcoin and Ether shared a particular function within the cryptocurrency market that made them basically completely different from Litecoin in the course of the related years. Nonetheless, whereas each cryptocurrencies share comparable qualities and makes use of, they’re additionally basically completely different from one another due to the distinction in total design, supposed use, and precise use. The Bitcoin community is designed to behave as a fee community for which Bitcoin acts because the unit of fee. The Ethereum blockchain, however, was supposed to behave as a fee community and as a platform for working sensible contracts and different purposes, with Ether working because the “gasoline” for these options. Thus, though Ether and Bitcoin could each be used to make funds, Ether’s extra performance differentiates Ether from Bitcoin in each nature and character. Subsequently, Bitcoin and Ether don’t qualify as like-kind property beneath part 1031.
As one can see, the IRS locations important emphasis on the performance of the cryptocurrency at challenge in a proposed change. The Service characterizes Bitcoin and Ether, for instance, as an “on and off-ramp for investments and transactions in different cryptocurrencies.” Litecoin, however, performed a “basically completely different function” from Bitcoin and Ether, differing in each “nature and character.” Seen via this analytical prism, the Service concluded that an change of those cryptocurrencies didn’t give rise to a like-kind change.
The IRS likewise decided that Ether’s “extra performance” induced it to be basically completely different in each nature and character from Bitcoin, main the IRS to carry that “Bitcoin and Ether don’t qualify as like-kind property beneath part 1031.”
Taxpayers with cryptocurrency holdings ought to search out recommendation and steerage from an skilled and credentialed tax legal professional for steerage with respect to cryptocurrency transactions. Cryptocurrency actions and transactions current many alternatives for tax planning and, sadly, tax pitfalls. Given the IRS’s continued deal with cryptocurrency tax reporting, for a lot of, the stakes might be excessive.