IRS: Certain Cryptocurrency Transactions Do Not Qualify as Like-Kind Exchanges

Posted in News, Offshore Account Update on June 30, 2021 | Share

In a recently-released Memorandum, the Internal Revenue Service (IRS) Office of Chief Counsel stated the agency’s position that certain transactions involving Bitcoin, Ether and Litecoin do not qualify as like-kind exchanges under Section 1031 of the Internal Revenue Code. As Washington D.C. tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, explains, this has potentially significant implications for U.S. taxpayers who invest in the cryptocurrency market.

About the Section 1030 Like-Kind Exchange Rule

The Section 1030 like-kind exchange rule allows U.S. taxpayers to defer tax on certain types of transactions that involve exchanging one asset for a similar type of asset. The most common example is real estate. If a U.S. taxpayer purchases a property for investment purposes, sells the property and then uses the proceeds to purchase another, the taxpayer is able to defer any tax liability until he, she or it eventually exits the real estate market. The like-kind exchange rule affords a significant tax benefit, and it theoretically allows taxpayers to defer their relevant tax liability indefinitely.

Why Don’t Cryptocurrency Trades Qualify as Like-Kind Exchanges?

According to the IRS Office of Chief Counsel’s Memorandum, certain trades involving Bitcoin, Ether and Litecoin do not qualify for tax deferral under Section 1030. This applies specifically to exchanges of (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin and (iii) Ether for Litecoin conducted prior to January 1, 2018. However, the Memorandum also states that it does not address any other cryptocurrencies or any transactions other than the three listed, and that, “[a]ccordingly, no inferences should be made based on this chief counsel advice that are not explicitly set forth.”

In other words, it is still very possible that the IRS will consider other cryptocurrency trades to be ineligible for tax deferral under the like-kind exchange rule.

Why has the IRS Office of Chief Counsel Made this determination, and why is it specific to the three types of exchanges listed above? The Memorandum was issued in response to a question regarding these three types of exchanges, and specifically the tax implications of these types of exchanges prior to January 1, 2018. With regard to why the IRS Office of Chief Counsel made its determination, the Memorandum focuses on the differences between Bitcoin, Ether and Litecoin, summarizing as follows:

“Bitcoin and Ether shared a special role in the cryptocurrency market that made them fundamentally different from Litecoin during the relevant years. However, while both cryptocurrencies share similar qualities and uses, they are also fundamentally different from each other because of the difference in overall design, intended use, and actual use.”

Based on this analysis, the Memorandum concludes that Bitcoin, Ether and Litecoin were not sufficiently similar in the years prior to 2018 to qualify for like-kind exchange treatment under Section 1030 in the circumstances discussed above.

Request a Consultation with Washington D.C. Tax Attorney Kevin E. Thorn

What does this mean for cryptocurrency investors? Due to the specific focus of the Memorandum, its broader implications remain to be determined. However, it is clear that the IRS is heavily focused on cryptocurrency, and investors must be extremely careful when preparing their annual returns. To discuss your crypto taxes with Washington D.C. tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, call 202-349-4033, email or contact us confidentially online today.

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