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Protocol Upgrade to Blockchain Distributed Ledger Does Not Result in Gain or Loss

(Parker Tax Publishing April 2023)

The Office of Chief Counsel advised that an individual who holds units of cryptocurrency native to a blockchain distributed ledger that undergoes a protocol upgrade does not realize gain or loss on the units under Code Sec. 1001 as a result of the protocol upgrade. The Chief Counsel's Office also advised that the taxpayer does not have an item of gross income under Code Sec. 61(a) as a result of the protocol upgrade. CCM 202316008.


K is a blockchain that uses distributed ledger technology to record transactions involving cryptocurrency pursuant to K's underlying protocol. The K blockchain protocol is a set of rules that includes a consensus mechanism for adding new blocks of transactions to K, including those involving units of cryptocurrency. Participants that successfully add new blocks of transactions to K receive a block reward in accordance with K's underlying protocol.

On Date 1, a taxpayer purchased 10 units of cryptocurrency and stored the private keys in an unhosted wallet. On Date 2, K changed its consensus mechanism used to select who may validate transactions and add blocks of transactions to the K blockchain from proof-of-work (PoW) to proof-of-stake (PoS) (protocol upgrade).

After the protocol upgrade on Date 2, K's protocol requires that transactions be validated and that new blocks be added to K's blockchain exclusively through the PoS consensus mechanism. The protocol upgrade does not affect or otherwise change the transaction history of any blocks prior to Date 2, and new blocks will be added to K pursuant to the changed protocol. Units of cryptocurrency remain unchanged following the protocol upgrade, and the taxpayer continues to hold the same 10 units of cryptocurrency. The taxpayer does not receive any cash, services, or property (including additional units of cryptocurrency) as a result of the protocol upgrade.

Digital assets are defined under Code Sec. 6045(g)(3)(D) as digital representations of value that are recorded on a cryptographically secured distributed ledger. Digital assets do not exist in physical form and include, but are not limited to, property the IRS has previously referred to in Notice 2014-21 and Rev. Rul. 2019-24 as convertible virtual currency and cryptocurrency. Notice 2014-21 provides that convertible virtual currency is treated as property and that general tax principles applicable to property transactions apply to convertible virtual currency.

Cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Units of cryptocurrency are generally referred to as coins or tokens. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality.

Code Sec. 1001 provides rules for the computation and recognition of gain or loss related to the sale or other disposition of property. Reg. Sec. 1.1001-1(a) provides that the gain or loss realized from the exchange of property for other property differing materially either in kind or in extent is treated as income or as loss sustained. An exchange of property is a realization event under Code Sec. 1001 only if the exchange results in the receipt of property that is materially different from the property transferred. In Cottage Savings Assn. v. Comm'r, 499 U.S. 554 (1991), the Supreme Court held that, for properties to be "different" in the sense of being "material" for purposes of Code Sec. 1001, they must embody legally distinct entitlements.

Code Sec. 61(a) generally provides that gross income means all income from whatever source derived, including gains from dealings in property. In Comm'r v. Glenshaw Glass Co., 348 U.S. 426 (1955), the Supreme Court held that all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion, are included in gross income. As stated by the Supreme Court in discussing an earlier version of Code Sec. 61 in Comm'r v. Jacobson, 336 U.S. 28 (1949), the term income should be "broadly construed" in accordance with an obvious purpose to tax income comprehensively.

In general, the excess of the fair market value of property or services over which the taxpayer has dominion and control reduced by the amount, if any, paid by the taxpayer shall be includible in gross income. Under Reg. Sec. 1.61-1(a), gross income includes income realized in any form, whether in money, property, or services. Income may be realized, therefore, in the form of services, meals, accommodations, stock, or other property, as well as in cash.


According to the Chief Counsel's Office, the protocol upgrade affects the consensus mechanism by which future transactions are validated and blocks are added to K after Date 2. However, the Chief Counsel's Office found that the protocol upgrade does not alter past transactions or blocks previously validated and added to K, including the taxpayer's 10 units of cryptocurrency. Furthermore, the Chief Counsel's Office advised that existing units of cryptocurrency remain unchanged by the protocol change and there is not an exchange of the units of cryptocurrency under Code Sec. 1001. Accordingly, the Chief Counsel's Office concluded that the taxpayer continues to own the same 10 units of cryptocurrency before and after the upgrade and the protocol upgrade does not result in a realization event from which the taxpayer realizes gain or loss on the taxpayer's existing 10 units.

Similarly, the Chief Counsel's Office advised that the taxpayer derives no accession to wealth from the upgrade. The taxpayer's 10 units of cryptocurrency, the Chief Counsel's Office found, remain unchanged after the upgrade, and the taxpayer does not derive any separable economic benefits, in the form of cash, services, or other property (including other cryptocurrencies) from it. The Chief Counsel's Office advised that, in the absence of an accession to wealth to the taxpayer, the protocol upgrade does not result in the taxpayer having an income inclusion within the meaning of Code Sec. 61(a).

For a discussion of virtual currency transactions, see Parker Tax ¶119,600.

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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