The IRS recently released guidance (ILM 202124008) holding that certain exchanges of Bitcoin, Ether, and Litecoin that occurred before the Tax Cuts and Jobs Act (TCJA) do not qualify for like-kind exchange treatment under Section 1031.
Prior to TCJA’s enactment, Section 1031 provided that no gain or loss was recognized on the exchange of property for property of a like-kind, which could have included exchanges of some personal property and exchanges of real property. The TCJA amended Section 1031 to provide that Section 1031 treatment was restricted to exchanges of real property.
Generally, in order to qualify for like-kind exchange treatment, the property exchanged must be the same nature or character (not the grade or quality).
In prior guidance, the IRS established that virtual currency was property for U.S. federal income tax purposes, and that general tax principles applicable to property transactions apply to transactions involving convertible virtual currency. The IRS concluded in the new guidance that exchanges of: (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin, or (iii) Ether for Litecoin prior to 2018 do not qualify as a like-kind exchange under Section 1031.
The IRS cited two old revenue rulings (Rev. Rul. 79-143 and Rev. Rul. 82-166) that each ruled that Section 1031 did not apply to support its conclusions. For example, Rev. Rul. 82-166 concluded that an investor who exchanged gold bullion for silver bullion was required to recognize gain because gold bullion was not like-kind property with respect to silver bullion for purposes of Section 1031.
In its analysis, the IRS compared Litecoin to Bitcoin and Ether and determined that Bitcoin and Ether “played a fundamentally different role from other cryptocurrencies” during 2016 and 2017. The IRS noted that Bitcoin and Ether were the most regarded cryptocurrencies and served as an “on-and-off ramp” because taxpayers often needed to purchase Bitcoin or Ether before being able to purchase another coin, such as Litecoin.
The IRS also concluded that Bitcoin and Ether were not like-kind property because of their differences in overall design, intended use, and actual use.
Jeff Borghino is a partner in the corporate tax group of Grant Thornton’s Washington National Tax Office in Washington, D.C. He focuses primarily on the taxation of corporate and financial transactions, including taxable and tax-free acquisitions, general corporate tax matters, recapitalizations and debt workouts, and financial instruments. Prior to joining the Washington National Tax Office, Borghino worked in Grant Thornton’s San Francisco office as part of the federal tax group.
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