Chief Counsel's Office Says No Section 165 Deduction for Decline in Value of Cryptocurrency

(Parker Tax Publishing January 2023)

The Office of Chief Counsel advised that a taxpayer, who purchased for personal investment cryptocurrency in 2022 for $1 per unit that declined in value to less than one cent per unit at the end of 2022, did not sustain a loss under Code Sec. 165. According to the Chief Counsel's Office, the taxpayer did not abandon or otherwise dispose of the cryptocurrency and the cryptocurrency was not worthless because it still had value; further, even if the taxpayer sustained a loss under Code Sec. 165, the loss would be disallowed because, under Code Sec. 67(g), miscellaneous itemized deductions were suspended for tax years 2018 through 2025. CCM 202302011.

Background

For personal investment purposes, an individual taxpayer purchased units of cryptocurrency in 2022 at $1 per unit on a cryptocurrency exchange. After the taxpayer acquired the cryptocurrency, the per unit value of the cryptocurrency decreased significantly, such that each unit was valued at less than one cent at the end of 2022. On December 31, 2022, the cryptocurrency continued to be traded on at least one cryptocurrency exchange, and the taxpayer maintained dominion and control over the units of cryptocurrency as evidenced by the taxpayer's ability to sell, exchange, or transfer the units. The taxpayer claimed a deduction on the taxpayer's 2022 tax return under Code Sec. 165 and took the position that the units of cryptocurrency were either worthless or abandoned.

Code Sec. 165(a) provides a deduction for losses sustained during the tax year and not compensated for by insurance or otherwise. A loss is allowed as a deduction under Code Sec. 165(a) only for the tax year in which the loss is sustained. Under Reg. Sec. 1.165-1(d)(1), a loss is treated as sustained during the tax year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such tax year.

Reg. Sec. 1.165-2(a) provides that a taxpayer sustains a loss under Code Sec. 165(a) for the obsolescence or loss of usefulness of nondepreciable property if: (1) the loss is incurred in a business or a transaction entered for profit; (2) the loss arises from the sudden termination of usefulness in the business or transaction; and (3) the property is permanently discarded from use, or the transaction is discontinued.

For individual taxpayers, Code Sec. 67(b)(3) characterizes Code Sec. 165(a) losses, other than those from casualty, theft, and wagering, as miscellaneous itemized deductions. Under current law, Code Sec. 67(g) disallows all miscellaneous itemized deductions for tax years beginning after December 31, 2017, and before January 1, 2026.

Observation: Code Sec. 165(g) provides that if any security which is a capital asset becomes worthless during the tax year, the loss is treated as a loss from the sale or exchange of a capital asset. Code Sec. 165(g)(2) defines a security as a share of stock in a corporation; a right to subscribe for, or to receive, a share of stock in a corporation; or a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or a government or political subdivision thereof, with interest coupons or in registered form. The Chief Counsel's Office advised that the cryptocurrency at issue is none of the items listed in Code Sec. 165(g)(2), and therefore Code Sec. 165(g) does not apply.

Analysis

The Chief Counsel's Office advised that no loss under Code Sec. 165 was allowed on the diminution of value of the cryptocurrency because, although the cryptocurrency has substantially decreased in value, its value was greater than zero, it continued to be traded on at least one cryptocurrency exchange, and the taxpayer did not sell, exchange, or otherwise dispose of the units of the cryptocurrency. The Chief Counsel's Office explained that a 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. According to the Chief Counsel's Office, 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 Chief Counsel's Office noted that a loss may be sustained, however, if a cryptocurrency becomes worthless, resulting in an identifiable event that occurs during the tax year for purposes of Code Sec. 165(a). Worthlessness is a question of fact and, in the case of a worthless asset, it is not necessary to relinquish title where there is (1) a subjective determination of worthlessness in a given year coupled with (2) a showing that in such year the asset in question is in fact essentially valueless. The Chief Counsel's Office noted that in MCM Investment Management, LLC v. Comm'r, T.C. Memo. 2019-158, the Tax Court found that a taxpayer subjectively determined that its partnership interest was worthless and, to determine whether there were also objective indicia of worthlessness, examined whether the partnership interest had liquidating value or any potential future value. Because the taxpayer could recover nothing for its partnership interest upon liquidation of the partnership and because there was no potential future value due to third-party subordinated debt agreements, the Tax Court determined that the partnership interest was worthless.

The Chief Counsel's Office said that in the instant case, each unit of cryptocurrency had liquidating value, though it was valued at less than one cent at the end of 2022. The cryptocurrency continued to be traded on at least one cryptocurrency exchange, allowing for the possibility that it may increase in value in the future. Accordingly, the Chief Counsel's Office concluded that the cryptocurrency was not wholly worthless during 2022 as a result of its decline in value, and the taxpayer did not sustain a bona fide loss under Code Sec. 165(a) in 2022 due to worthlessness.

Turning to the issue of abandonment, the Chief Counsel's Office noted that the taxpayer did not take any action to abandon and permanently discard the taxpayer's units of cryptocurrency during 2022. The Chief Counsel's Office explained that abandonment is proven through an evaluation of the surrounding facts and circumstances, which must show: (1) an intention to abandon the property, coupled with (2) an affirmative act of abandonment. Some express manifestation of abandonment is required when the asset is an intangible property interest.

In this case, the Chief Counsel's Office concluded that the taxpayer maintained ownership of the cryptocurrency through the end of 2022, even though the value of each unit of the cryptocurrency as of the end of the year was less than one cent. The Chief Counsel's office noted that the taxpayer retained the ability to sell, exchange, or otherwise dispose of the cryptocurrency during 2022. Furthermore, the taxpayer continued to exert dominion and control over the cryptocurrency and, regardless of intent, did not take any affirmative steps to abandon the property during 2022. Therefore, the Chief Counsel's Office concluded that the taxpayer did not sustain a loss pursuant to Code Sec. 165(a) in 2022 due to abandonment.

For a discussion of the general rules for deducting losses, see Parker Tax ¶84,503.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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