Episode 256 – Cryptocurrency can be a very volatile asset. If the cryptocurrency falls significantly in value, that loss may not be entitled to a Section 165 loss deduction on the investor’s income tax return.

Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode, No Section 165 Loss Deduction for Bitcoin.

Since it was first created in January 2009 when Bitcoin was released, cryptocurrencies or virtual currencies have become an increasingly popular alternative to actual currencies used for payments, or as an alternative investment. Cryptocurrencies are created using encryption algorithms stored in a cryptocurrency wallet. These wallets tend to be software-based and stored on a cloud-based service or on your computer or mobile device. The wallets store your encryption keys that confirm your identity and link to your cryptocurrency. Cryptocurrencies are not  assets that you can touch and feel like a dollar bill, gold coin, or a stock certificate that evidences ownership of shares in a company. As a result, the true value of cryptocurrencies has been hotly debated. The price volatility has also been an issue. For example, on November 9, 2021, Bitcoin reached its highest value at $67,617[1]. On October 11, 2023, Bitcoin closed at $27,140.75.[2]  “In 2013, Forbes named Bitcoin the year’s best investment. In 2014, Bloomberg countered with its proclamation of Bitcoin being the year’s worst investment.”[3]

It is that price volatility that the IRS recently addressed from an income tax perspective. On January 13, 2023, the Office of Chief Counsel for the Internal Revenue Service issued a memorandum[4] addressing whether a cryptocurrency, that substantially decreased in value, such that it was essentially deemed worthless or abandoned, could be written off as a tax loss pursuant to Internal Revenue Code Section 165.  Section 165(g) recognizes that a security, such as corporate stocks or bonds, is a capital asset that could be treated as a loss from the sale or exchange of the asset if the security became worthless.

In this situation, the taxpayer purchased a cryptocurrency for $1 per unit at the beginning of 2022 but by the end of the year, it was only worth 1 cent. However, the cryptocurrency could still be traded on at least one cryptocurrency exchange, and the taxpayer maintained dominion and control over the units. The Taxpayer could still sell, exchange, or transfer the units. In addition, the IRS opined that cryptocurrencies are not a security nor capital asset as defined in IRC Sec. 165. The IRS noted that the taxpayer also did not take any action to abandon or permanently discard the cryptocurrency units. Therefore, the loss deduction was disallowed.

So, what can you learn from this IRS Chief Counsel memorandum? Aside from the great volatility in value, making cryptocurrencies quite speculative, they are still increasing in popularity. But, they are still new commodities or assets and therefore, the body of law that regulates or controls them is still undeveloped.  The same goes for the tax laws impacting them. This yields results that may be different from other types of assets.

Before you decide to invest or transact in cryptocurrencies, you may wish to discuss this with your tax and legal advisors first.

[1] GlobalData. “Bitcoin’s Price History (2013-2023, $).” Globaldata.com
https://www.globaldata.com/data-insights/financial-services/bitcoins-price-history/ (accessed October 13, 2023).

[2] Yahoo Finance. “Bitcoin USD (BTC-USD).” Ca.finance.yahoo.com

https://ca.finance.yahoo.com/quote/BTC-USD/history/ (accessed October 13, 2023).

[3] Pinkerton, Julie. “The History of Bitcoin, the First Cryptocurrency.” Money.usnews.com https://money.usnews.com/investing/articles/the-history-of-bitcoin%20 (accessed October 30, 2023).

[4] Internal Revenue Service. Office of Chief Counsel Memorandum No. 202302011. Jan. 13, 2023.
https://www.irs.gov/pub/irs-wd/202302011.pdf (accessed October 30, 2023).

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