Can You Claim a Deduction for Decline in Cryptocurrency Value? Check the IRS’s Opinion First

Robert L. Tobey, CPA, Partner

SUMMARY

On January 13, 2023, the IRS Chief Counsel Memorandum (CCM) 202302011 was issued, stating that:

1. in the case of a taxpayer that owns cryptocurrency that substantially declined in value, and
2. the taxpayer has not sold or exchanged the cryptocurrency in a taxable transaction, and
3. the cryptocurrency continues to trade on at least one cryptocurrency exchange,

that the taxpayer cannot claim a worthlessness or abandonment loss under Internal Revenue Code (IRC) §165 with respect to the substantial value decline.

DISCUSSION

For federal income tax purposes, cryptocurrency is treated as property like stocks and securities (i.e: securities). However, cryptocurrency is not a security (this distinction is beyond the scope of this article which I’ll address in the future). With respect to securities, a loss is not recognized merely due to a decline in value. The same is true for cryptocurrency. To claim a loss with respect to securities or cryptocurrency, a taxpayer must dispose of the stock or cryptocurrency in a taxable sale or exchange. The recognized loss is a capital loss.

Worthlessness losses occur with respect to an asset for which compensation (e.g.: insurance) is not received, or all hope of value recovery is lost (e.g.: settled bankruptcy). If a security becomes worthless during a tax year, the resulting loss is treated as a loss from the sale of exchange on the last day of the tax year in which the loss occurs.

Abandonment losses occur in a trade of business transactions entered into for profit. Abandonment losses arise from the sudden and unexpected termination of an asset’s usefulness in a trade or business, the discontinuance of a trade or business or transaction, or from the permanent discarding of a non-depreciable asset. To prove permanent abandonment, a taxpayer must show evidence of an intention to abandon the property, and an affirmative act of abandonment.

Usually, individual taxpayers hold cryptocurrency as investments, not as assets used in a trade or business. Consequently, worthlessness or abandonment losses are miscellaneous itemized deductions. Since enactment of the Tax Cuts and Jobs Act (TCJA) in 2017, these deductions are disallowed.  Additionally, under pre-TCJA, miscellaneous itemized deductions are addbacks for Alternative Minimum Tax (AMT) purposes. Accordingly, any tax benefits for individuals claiming worthlessness or abandonment losses are eliminated.

In this CCM, the IRS states that while the cryptocurrency had substantially decreased in value, there was no deductible loss because its value was greater than zero, it continued to be traded on at least one cryptocurrency exchange and the taxpayer did not, in a taxable transition, sell, exchange, or otherwise dispose of the cryptocurrency.

Relying on existing case law, the IRS states that the “mere diminution in value of property does not create a deductible loss. An economic loss in the value of property must be determined by the permanent closing of a transaction with respect to the property. A decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as abandonment, sale, or exchange.”¹

Additional case law states that there must be an identifiable event supporting the fact that there is no current liquidating value and no value to be acquired in the future. Because the cryptocurrency still had a liquidating value (even if it was valued at less than one cent) and because it was still possible for the value to increase in the future given that it was traded on at least one cryptocurrency exchange, the cryptocurrency in question was not wholly worthless during 2022 because of its decline in value. Therefore, the taxpayer did not sustain a bona fide loss under IRC §165(a) because of worthlessness.

CCMs are not precedential nor can be relied upon or cited as precedent. Nevertheless, this guidance is useful as background or insight on how the IRS may treat an undecided or novel issue for which no other IRS guidance is available.

Source:

1. IRS releases memorandum on deducting cryptocurrency losses. McDermott Will & Emery. (2023, February 1). Retrieved February 2, 2023, from https://www.mwe.com/insights/irs-releases-memorandum-on-deducting-cryptocurrency-losses/