Following the demise of the cryptocurrency exchange platform FTX, many taxpayers are studying how they can harvest tax losses associated with their devalued crypto assets. To better assess those options, taxpayers should be mindful of the IRS's position for the tax provisions relating to losses in a January 10th Chief Counsel Advice (CCA). The CCA concluded that a taxpayer who owns cryptocurrencies that substantially declined in value may not deduct those losses on the basis that (i) the crypto asset is worthless or (ii) abandoned, in addition to a larger limitation that the deduction would be disallowed under the miscellaneous itemized deductions between the years 2018 through and including 2025.1
Very generally, losses are deductible if they are "sustained during the taxable year" and are "evidenced by closed and complete transactions, fixed by identifiable events."2 According to the CCA, a decline in the value of the cryptocurrency does not in and of itself qualify for a tax deduction; the taxpayer must dispose of the asset and relinquish control and dominion, either via sale or total abandonment. However, if a cryptocurrency is determined to be worthless and is no longer saleable, it may rise to an "identifiable event" that would allow a tax deduction. Whether an asset is "worthless" turns on facts and circumstances. A tax deduction based on "abandonment" of the property turns on proving whether the taxpayer has (i) shown an intention to abandon the property and (ii) has taken an affirmative act of abandonment. Intention alone does not suffice; the taxpayer must show an affirmative act. In the facts set out in the CCA, the taxpayer did not demonstrate the abandonment of the cryptocurrency. Even though the cryptocurrency was valued at less than a cent, the taxpayer continued to own it (ergo, did not sell or swap it for another coin). Additionally, the taxpayer never demonstrated an intention coupled with an affirmative action to abandon the cryptocurrency, thereby failing to meet the requirement of abandonment for the loss to be allowed. 3
Consider the following example. On Day A, Justin purchases X Coin at $100 on Y Exchange. On Day Z, X Coin drops in value to $1. Justin is very upset that his investment went sour. He leaves X Coin on Y Exchange at its current value of $1 and proceeds to file his income tax return for the relevant year, taking a loss-at-cost basis on his return ($99). Justin will likely have to revise the return upon an IRS audit because he neither (i) relinquished control nor (ii) abandoned his property (X Coin). Furthermore, X Coin continues to be available on Y Exchange, albeit at a much lower price point (ergo, $1), thereby losing the argument that X Coin is now worthless.
The importance of the CCA is to remind taxpayers that the IRS is paying close attention to taxpayer return positions, specifically as it relates to crypto losses, and to be mindful of potentially aggressive positions that are likely to be second-guessed. To read more click here.