Office of Chief Counsel Provides Advice on Two Cryptocurrency Tax Issues

Cryptocurrency Tax Considerations for Taxpayers

With the recent bankruptcy filings of FTX and affiliated companies, cryptocurrencies have been in the news a great deal over the past several weeks.

If you invested in digital currency, you may be looking for ways to turn losses into possible tax breaks. The Chief Counsel, the chief legal advisor to the IRS Commissioner on all matters pertaining to the interpretation, administration and enforcement of the Internal Revenue Laws, recently provided interpretive advice to taxpayers on two issues related to cryptocurrencies.

1. IRC Section 165

Can a taxpayer claim their cryptocurrency as a worthless security under IRC Section 165?

Scenario                         

A taxpayer purchased units of Cryptocurrency in 2022 at a price of $1 per unit. During 2022, the units decreased until is was worth less than a penny per unit. The taxpayer claimed a loss on their tax return for 2022 under Section 165 claiming that the investment was either worthless or abandoned.

IRS Chief Counsel Advice

The Chief Counsel Advice (“CCA”) determined that the taxpayer could not claim the loss for worthlessness under Section 165 because cryptocurrency is not listed as a qualifying security under Section 165(g). In addition, the CCA stated that the cryptocurrency could not be considered worthless under Section 165 because it was still being traded at least one other cryptocurrency exchange. Since it was still being traded, the taxpayer could not meet the requirements for the cryptocurrency investment to be considered worthless as it still held some value. In order to claim the deduction under Section 165, the taxpayer must prove that investment has no value to claim worthlessness or to claim an abandonment loss, the taxpayer must proceed with some action to affirm the taxpayer’s exit from the investment such as relinquishment of rights to the investment, or sale, or exchange of the asset. Access the CCA’s full memorandum: CCA 202302011.

Are there other options for claiming a cryptocurrency loss on taxes?

Alternatively, using the scenario from above as an example, the taxpayer could have sold the cryptocurrency and claimed the loss due to the sale.

2. IRC Section 170(f)

What are the requirements for claiming a charitable contribution of property deduction using cryptocurrency?

Scenario

A taxpayer made a donation of more than $5,000 to a charitable organization. To substantiate the contribution deduction, the taxpayer used a valuation obtained from a cryptocurrency exchange.

IRS Chief Counsel Advice

IRC Section 170(f) contains certain substantiation requirements in order for a taxpayer to claim a charitable contribution of property. Generally, if a taxpayer makes a contribution of appreciated property that is in excess of $5,000, the taxpayer must obtain a “qualified appraisal “of the property. The appraisal must be made on a timely basis with respect to the date of the contribution. In CCA 202302012, the IRS disallowed the charitable  contribution deduction because the taxpayer did not satisfy the qualified appraisal requirements. Cryptocurrency is not one of the types of property exempt from the appraisal requirement contained in the substantiation regulations under Section 170. The CCA also stated that the use of the exchange’s value and not an appraisal of the property would not meet the reasonable cause exception, and as a result penalties would apply. Access the CCA’s full memorandum CCA 20230212.

Note: These same appraisal requirements also apply to charitable contributions of precious metals and coins.

Increase in tax audits of contribution deductions of appreciated property

Our tax practice is seeing increased audit activity by the IRS in challenging contribution deductions of appreciated property. In order to meet the substantiation requirements, it is very important to satisfy the rules related to a qualified appraisal and to make sure that all of the information related to the property contributed is completed on the IRS Form 8283 and explanations are attached.

Please reach out to your Keiter Opportunity Advisor for assistance in sorting through the virtual currency rules. The rules are ever changing and expanding so you will need to be sure that you have the needed documentation to properly report virtual currency transactions.