On June 18, 2021, the IRS issued IRS Legal Memo 202124008, by which it concludes that swaps of sure cryptocurrencies can’t qualify as tax-deferred “like-kind” exchanges underneath Part 1031 of the Code because it existed previous to its modification in 2017.
Beneath Part 1031, taxpayers might defer tax on positive aspects once they promote sure property and reinvest the proceeds into comparable property (so-called like-kind exchanges). For exchanges occurring on or after January 1, 2018, the Tax Cuts and Jobs Act (TCJA) restricted the supply of Part 1031 to exchanges of actual property, excluding all different property, together with cryptocurrency.
Earlier than being amended by the TCJA, Part 1031 was obtainable for exchanges of many types of property, supplied the taxpayer purchased property that counts as like-kind to what the taxpayer offered. We perceive that many traders in cryptocurrency took the place that swaps of 1 cryptocurrency for one more certified for tax deferral underneath Part 1031, a place the Memo instantly disputes.
As mentioned within the Memo, within the context of non-public property (resembling cryptocurrency), the foundations for figuring out what’s like-kind are way more slim than these for actual property, and require the substitute property to be similar to the property offered.
Part 1.1031(a)-1(b) of the Treasury Laws defines “like variety” to imply the character or character of the property and never the grade or high quality, and supplied that one variety or class of property is probably not exchanged for property of a unique variety or class. Prior IRS steerage interprets this rule narrowly. For instance, in Income Ruling 82-166, the IRS held that gold bullion is just not like-kind to silver bullion as a result of the worth of silver is derived largely from industrial makes use of whereas the worth of gold is derived largely from funding and hypothesis. Additional, in Income Ruling 79-143, the IRS held that numismatic-type cash (ie, cash deriving worth from age, shortage, historical past, or aesthetics) usually are not like-kind to bullion-type cash (ie, cash deriving worth from metallic content material). Within the Memo, the IRS utilized these authorities to exchanges of Bitcoin for Litecoin, of Ether for Litecoin, and of Bitcoin for Ether.
For exchanges involving Litecoin, the Memo describes the distinctive function that Ether and Bitcoin play with respect to such exchanges. So as to purchase Litecoin, a dealer typically should give Bitcoin or Ether in alternate, and with a purpose to promote Litecoin, a dealer typically should obtain Bitcoin or Ether in alternate. The Memo notes that “[u]nlike 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, in line with the IRS, every differed in each nature and character from Litecoin, and subsequently don’t qualify as property that’s like-kind with Litecoin. In consequence, the Memo concludes that exchanges of Litecoin for Bitcoin or Ether usually are not eligible for Part 1031 tax-deferred alternate remedy.
For exchanges of Bitcoin and Ether, the Memo once more notes their distinctive place within the cryptocurrency market, however nonetheless concludes that “whereas each cryptocurrencies share comparable qualities and makes use of, they’re additionally basically totally different from one another due to the distinction in total design, meant use, and precise use,” and thus usually are not like-kind with respect to one another. Particularly, the IRS famous that the Bitcoin community is designed to behave as a fee community, with Bitcoin being the unit of fee, whereas the Ethereum blockchain is each a fee community and a platform for working good contracts and different purposes, with Ether facilitating these options. In consequence, the Memo concludes that exchanges of Bitcoin for Ether (or vice versa) usually are not eligible for Part 1031 tax-deferred alternate remedy.
Whereas the Memo solely addresses exchanges of three particular cryptocurrencies, it appears cheap to imagine that the IRS would apply its evaluation within the Memo to most different cryptocurrencies. For taxpayers who swapped cryptocurrencies on or earlier than December 31, 2017, and took the place that such exchanges certified for tax deferral underneath Part 1031, if the IRS’s place within the Memo is sustained, these taxpayers could also be accountable for again taxes, curiosity and/or penalties for these transactions. Doubtlessly affected taxpayers ought to seek the advice of their tax advisors to debate implications of the Memo, together with whether or not the statute of limitations stays open and whether or not the taxpayer ought to file amended tax returns.