IRS addresses deduction of crypto losses in recent advice

The IRS has released a Chief Counsel Advice Memorandum addressing whether taxpayers may deduct losses derived from cryptocurrency that has declined in value, even precipitously, without a sale or other disposition event.

In an unsurprising analysis, issued on January 13, 2023, the CCA provides that a taxpayer may not claim any such loss if the cryptocurrency continues to be traded on an exchange and has a value greater than zero and the taxpayer has not taken some affirmative step that fixes the amount of the loss, such as abandonment, sale, or exchange.

The CCA also notes that, even if a taxpayer properly established a worthlessness or abandonment deduction for cryptocurrency for 2022, deductions for worthlessness or abandonment are generally disallowed for tax years from 2018 through 2025. Accordingly, individual taxpayers holding cryptocurrency for investment appear to be unable to deduct any losses without a disposition event.

Worthlessness

As mentioned, the CCA clarifies that cryptocurrency cannot be considered worthless if it has a value of more than zero and is still traded on an exchange. In explaining its rationale, the CCM relies on case law generally holding that a diminution in value of property does not create losses because the loss is not also accompanied by an affirmative step that fixes the loss, for example, a disposition event.

However, the CCA notes that where cryptocurrency actually becomes worthless – that is, results in an identifiable event that occurs in accordance with section 165(a) of the Code, a loss may be sustained. Whether an asset is worthless is a question of fact and takes into account a subjective view of whether the asset is valueless. Despite this, the asset must also be of zero value objectively.

Abandonment

Section 165 of the Code and applicable Treasury regulations thereunder also provide that a loss may be claimed for abandoned property where (1) the loss must be incurred in a trade or business or in a transaction entered into for profit, (2) the loss must arise from the sudden termination of usefulness in the trade, business or transaction and (3) the property must be permanently discarded from use or from a transaction that is discontinued. See Treas. Reg. 1.165-2(a). Abandonment is generally established on a facts and circumstances basis showing both an intention to abandon and an affirmative act of abandonment.

In the example provided for abandonment, a loss was not sustained because the taxpayer held cryptocurrency with value of less than one cent thereby continuing to exercise control over it and retaining ability to sell. Because the taxpayer did not take any affirmative action to abandon the property, a less due to abandonment is not permitted. This seems to confirm that a deduction may be taken if the taxpayer can demonstrate an intent to abandon and associated affirmative acts in pursuit of such abandonment.

While the CCA is not binding on any particular taxpayer, it does provide some insight as to the IRS’ current thinking on developments in the cryptocurrency market; in particular, the CCA signals that the IRS will be challenging taxpayer’s loss deductions related to declines in cryptocurrency values.  The CCA also leaves much to be desired – for example, under current circumstances where some exchange assets may be frozen in bankruptcy, the CCA does not help in understanding scenarios where a taxpayer is unable to abandon due to frozen assets.