The IRS has released an internal legal memorandum (ILM 202316008) that discusses the tax consequences of a cryptocurrency protocol upgrade.
The ILM addresses whether the protocol update results in a realized gain or loss under Section 1001 and whether the taxpayer has an item of gross income under Section 61(a).
In the ILM, the taxpayer purchased 10 units of a cryptocurrency and stored them in an un-hosted wallet. The blockchain later underwent a protocol upgrade, switching from a proof-of-work to a proof-of-stake consensus mechanism.
Under Section 1001, an exchange of property is a realization event if the exchange results in the receipt of property that is materially different from the property transferred.
The IRS held that the protocol update merely changes the way that transactions are validated and does not have any effect on the units of cryptocurrency held — the change did not affect, or otherwise change, the transaction history of any blocks. Hence, a protocol upgrade will not result in a realization event under Section 1001 because the units were unchanged by the protocol upgrade.
The IRS also concluded that the taxpayer does not have an item of gross income under Section 61(a) as a result of the protocol upgrade. Under Section 61(a), all gains or accessions to wealth, which have been realized and in which the taxpayer has complete dominion over, are included in gross income. As the taxpayer derived no accession to wealth, or any other separable economic benefits from the upgrade, the protocol upgrade did not result in the taxpayer having an income inclusion.
The IRS cited Cottage Savings and Glenshaw Glass in reaching its conclusions.
Partner, Washington National Tax Office
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.
Washington DC, Washington DC
Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.
More tax hot topics
No Results Found. Please search again using different keywords and/or filters.