February 1, 2023
US IRS addresses deductions involving cryptocurrency in two Chief Counsel Advice memos
In two CCAs, the IRS has issued "non-specific taxpayer" advice involving cryptocurrency transactions, both concluding that cryptocurrency is not a "security" under Internal Revenue Code1 (IRC) Section 165(g)(2). In CCA 202302011, the IRS determined that a taxpayer could not claim a loss deduction for cryptocurrency that had lost almost all its value; in CCA 202302012, the IRS determined that a taxpayer could not claim a charitable deduction for a donation of cryptocurrency that she had not had independently appraised.
Loss deduction — CCA 202302011
At issue in this CCA was whether Section 165 allows a loss deduction for a particular cryptocurrency (Cryptocurrency B) that had substantially declined in value. The taxpayer had purchased his Cryptocurrency B at US$12 per unit. In the tax year at issue, it was worth less than $0.01 per unit.
The taxpayer asserted he was entitled to a loss deduction because the cryptocurrency was either worthless or abandoned. One cryptocurrency exchange continued to trade in Cryptocurrency B.
The IRS Chief Counsel concluded that a Section 165 deduction was not permissible because the cryptocurrency (1) was not worthless, (2) had not been abandoned, and (3) could increase in value in the future. Even if the taxpayer's Cryptocurrency B met the requirements for claiming a total loss under Section 165, the CCA concluded, that loss may not be claimed for tax years 2018 through 2025, due to changes made under the Tax Cuts and Jobs Act of 2017, which suspended the deductibility of miscellaneous itemized deductions under Section 67(g).
Generally, taxpayers may deduct a loss in the year sustained if they have not been compensated for the loss by insurance (Section 165(a)). If a security that is a capital asset becomes worthless during the tax year, Section 165(g) treats the loss as a loss from the sale or exchange of a capital asset. Section 165(g)(2) lists items that constitute a security. In the CCA, the IRS notes that "Cryptocurrency B is none of the items listed in section 165(g)(2), and therefore section 165(g) does not apply."
The IRS concluded that the taxpayer's Cryptocurrency B could not be deemed worthless because it retained some value and the taxpayer had not realized an economic loss because he had not disposed of or abandoned the asset. "'The mere diminution in value of property does not create a deductible loss. An economic loss in 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,'" the IRS noted, citing Lakewood Assocs. v. Commissioner, 109 T.C. 450, 459. Further, the IRS asserted, the taxpayer's Cryptocurrency B could continue to be traded on at least one market and could increase in value.
The CCA concludes that the cryptocurrency in question could not be considered worthless because it had some value (albeit less than one cent). This conclusion is consistent with historical case law and should not come as a surprise.
Charitable contribution deduction — CCA 202302012
The facts in this CCA describe a taxpayer who donated Cryptocurrency B to a public charity and claimed a $10,000 charitable deduction but did not submit to the IRS, or attempt to attain, a qualified appraisal of the donated property. She asserted that a qualified appraisal was not necessary because Cryptocurrency B constituted "readily valued property."
Taxpayers generally must substantiate charitable deductions. To claim a donation deduction of $5,000 or more, the taxpayer must obtain a qualified appraisal under Section 170(f)(11)(E)(i) — i.e., an appraisal that is treated as a qualified appraisal under the regulations or other guidance and conducted by a qualified appraiser. A qualified appraiser must meet certain minimum education and experience requirements, in addition to other requirements.
A qualified appraisal is not required, however, for donations of certain "readily valued property" as described in the IRC and regulations. This property includes cash, stock, publicly traded securities, and more, but does not include cryptocurrency.
The IRS concluded that no exception to the qualified appraisal requirements applied to the facts described in the CCA. "Cryptocurrency B is not cash, a publicly traded security, or any other type of property listed in sections 170(f)(11)(A)(ii)(I) and 1.170A-16(d)(2)(i). Accordingly, since Taxpayer A claimed a charitable contribution deduction of over $5,000 for the donated cryptocurrency, a qualified appraisal is required," the IRS ruled.
The regulations support the IRS's position that a qualified appraisal is required. Taxpayers have encountered a similar issue with donations of publicly traded partnerships (PTPs) for decades. PTPs have a readily tradable market, a ticker symbol and a value that can be easily determined by established trading markets, yet still require an appraisal because they are not securities under the regulations. PTPs have the same hallmarks as cryptocurrency. This predicament presents challenges for taxpayers. A remedy would require (1) amending the regulations to expand the exception from appraisals for items other than securities as defined in Section 165(g), or (2) amending Section 170(f) to overrule the regulation.
One practical difficulty not addressed by the CCA is how to actually obtain a qualified appraisal of cryptocurrency. Given enough time and money, meeting the requirements in Treas. Reg. Section 1.170A-17(a) for a qualified appraisal may be possible, with one exception. Recall that a qualified appraisal must be completed by as qualified appraiser. Treas. Reg. Section 1.170A-17(b) defines a "qualified appraiser" as an individual with verifiable education and experience in valuing the type of property for which the appraisal is performed. What type of education is required to value cryptocurrency? For education and experience, the regulations go on to say that appraisers could be qualified if they (1) successfully completed (e.g., received a passing grade on a final examination) professional or college-level coursework in valuing the type of property and have two or more years of experience in valuing the type of property, or (2) earned a recognized appraiser designation for the type of property. For cryptocurrency, it is unclear what sort of qualifications would be required, considering that accredited professional or college-level coursework on cryptocurrency valuation is not widely available and no recognized appraiser designation for cryptocurrency appraisers yet seems to exist. This discussion is well beyond the narrow scope of the CCA but should have been addressed.
Exempt organization implications
Generally, a qualified charitable organization must provide donors with a contemporaneous written acknowledgement of their donation no later than 31 January of the year following the year in which the contribution was made. Tax-exempt organizations should include in their donor acknowledgements (1) the estimated value of cryptocurrency contributed, (2) whether the organization provided any goods or services to the donor in connection with the contribution, and (3) a description and good faith estimate of the value of the goods or services received by the donor from the organization. For a donor to qualify to deduct a gift as a charitable contribution, it must receive such an acknowledgement from the charity on or before the earlier of the donor's tax return filing date or the due date, including extensions, for filing the return. If the organization does not timely provide the acknowledgement to the donor, the donor's charitable contribution deduction is at risk of being denied.
In addition to providing a contemporaneous written acknowledgement, the qualified tax-exempt organization receiving the donation must complete part of the donor's Form 8283, Noncash Charitable Contributions. The donor must describe the property donated and include an appraiser declaration with the form; otherwise, the donor could be subject to penalties under Section 6695A for failure to provide a qualified appraisal. Based on the discussion above regarding the qualified appraiser requirements, this affirmation may be difficult to obtain, as a qualified appraiser of cryptocurrency may be difficult to find.
If an exempt organization that receives a cryptocurrency donation and signs a Form 8283 for the donation sells or otherwise disposes of the cryptocurrency within three years of receipt, the organization must file Form 8282, Donee Information Return (Sale, Exchange or Other Disposition of Donated Property), to report its sale/disposal. See Publication 526 for more information on Form 8282 and 8283 reporting requirements, including standards for the appraiser declaration.
The rising popularity of many different digital currencies may result in tax-exempt organizations receiving more cryptocurrency donations. Though the two CCAs discussed here mostly focus on tax implications of cryptocurrency donations for the donors, tax-exempt organizations also need to understand and consider the classification and treatment of these contributions. Because cryptocurrency is still rather new, many potential donors are likely unaware of the tax-related implications involved in giving cryptocurrency to charity. It may be beneficial for tax-exempt organizations to proactively inform their potential donors of the rules surrounding this issue (as described in the CCAs) and, in doing so, reduce the chance of potential reporting errors.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (United States), Private Client Services
Ernst & Young LLP (United States), Exempt Organization Tax Services
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor