A cryptocurrency price collapse alone does not create a deductible loss

Plain-English summary

An investor bought cryptocurrency for $1 per unit, retained control of it, and claimed a section 165 loss after its price fell below one cent. The IRS advised that a steep decline is not enough because the asset still traded on an exchange, retained some liquidating value, and could potentially rise again. The investor also had not sold, exchanged, transferred, or taken an affirmative act to abandon the units. No closed transaction, identifiable worthlessness event, or abandonment fixed a loss during the year. The advice added that even a section 165 loss of this kind would have been a miscellaneous itemized deduction suspended by section 67(g) for the year at issue.

Ruling snapshot

• Question: Did cryptocurrency that fell below one cent become worthless or abandoned when the investor still owned and controlled it?
• Outcome: Advice given, no section 165 loss was sustained
• Key authorities: IRC §§ 67(b)(3), 67(g), 165(a), and 165(g); Treas. Reg. §§ 1.165-1 and 1.165-2

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 202302011
       Release Date: 1/13/2023

       CC:ITA:B02
       POSTN-114640-22

UILC: 165.00-00, 165.13-00

date: January 10, 2023

 to:   Michael R. Fiore
       Area Counsel, 1 (Boston)
       (Small Business/Self-Employed)

from: Ronald J. Goldstein
Senior Technician Reviewer, Branch 2
(Income Tax & Accounting)

subject: Applicability of I.R.C. section 165 to cryptocurrency that has declined in value

              This Chief Counsel Advice responds to your request for non-taxpayer specific
       advice regarding the applicability of section 165 of the Internal Revenue Code (“Code”)
       to cryptocurrency that has substantially declined in value. This document should not be
       used or cited as precedent.

                                                  Issue

              Section 165 of the Code provides for the deduction of losses sustained during
       the taxable year. If Taxpayer A owns cryptocurrency that has substantially declined in
       value, has Taxpayer A sustained a loss under section 165 of the Code due to
       worthlessness or abandonment of the cryptocurrency?

                                               Conclusion

              No. Section 165 provides a deduction for losses that are evidenced by closed
       and completed transactions, fixed by identifiable events, and actually sustained during
       the taxable year. Taxpayer A has not abandoned or otherwise disposed of the
       cryptocurrency, and the cryptocurrency is not worthless because it still has value.
       Therefore, Taxpayer A has not sustained a loss under section 165 and the
       corresponding regulations. Further, even if Taxpayer A sustained a loss under section

POSTN-114640-22 2

165, the loss would be disallowed because section 67(g) suspends miscellaneous
itemized deductions for taxable years 2018 through 2025.

                                               Facts

    Taxpayer A is an individual who purchased units of Cryptocurrency B in 2022 at

$1.00 per unit for personal investment purposes on a cryptocurrency exchange. After
Taxpayer A acquired Cryptocurrency B, the per unit value of Cryptocurrency B
decreased significantly, such that each unit of Cryptocurrency B was valued at less than
one cent at the end of 2022. On December 31, 2022, Cryptocurrency B continued to be
traded on at least one cryptocurrency exchange, and Taxpayer A maintained dominion
and control over the units of Cryptocurrency B as evidenced by Taxpayer A’s ability to
sell, exchange, or transfer the units. Taxpayer A claimed a deduction on Taxpayer A’s
2022 tax return under section 165 and took the position that the units of Cryptocurrency
B were either worthless or abandoned.

                                           Discussion

   Digital assets are defined under section 6045(g)(3)(D) as digital representations

of value that are recorded on a cryptographically secured distributed ledger. 1 Digital
assets do not exist in physical form and include, but are not limited to, property the
Service has previously referred to as convertible virtual currency and cryptocurrency.
See Notice 2014-21, 2014-16 I.R.B. 938; Rev. Rul. 2019-24, 2019-44 I.R.B. 1004.
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. See Rev. Rul. 2019-24.

   Sales, exchanges, and other dispositions of digital assets may result in

recognition of gain or loss. The character of a gain or loss resulting from a disposition
of a cryptocurrency generally depends on whether the property is a capital asset in the
hands of the taxpayer. A taxpayer not in the trade or business of dealing in
cryptocurrency will generally realize capital gain or loss on the sale or exchange of a
cryptocurrency. A taxpayer realizes ordinary gain or loss on the sale or exchange of
property that is not held as a capital asset.

1 The Infrastructure Investment and Jobs Act (“the Act”), Pub. L. 117-58, div. H, title VI, section

80603(b)(1)(B), added new section 6045(g)(3)(D), which uses this definition of a digital asset for purposes
of information reporting by brokers effective January 1, 2023. The Act provides the Secretary with the
authority to further define the term “digital asset.”
POSTN-114640-22 3

   Section 165(a) of the Code provides a deduction for losses sustained during the

taxable year and not compensated for by insurance or otherwise. A loss is allowed as a
deduction under section 165(a) only for the taxable year in which the loss is sustained.
For this purpose, a loss is treated as sustained during the taxable year in which the loss
occurs as evidenced by closed and completed transactions and as fixed by identifiable
events occurring in such taxable year. Treas. Reg. section 1.165-1(d)(1).

   Section 165(g) provides that if any security which is a capital asset becomes

worthless during the taxable year, the loss shall be treated as a loss from the sale or
exchange of a capital asset. Section 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. Cryptocurrency B is none of the items listed in section 165(g)(2), and
therefore section 165(g) does not apply.

   For individual taxpayers, section 67(b)(3) characterizes section 165(a) losses,

other than those from casualty, theft, and wagering, as miscellaneous itemized
deductions.2 Under current law, section 67(g) disallows all miscellaneous itemized
deductions for tax years beginning after December 31, 2017, and before January 1,
2026.

Worthless Cryptocurrency

   Cryptocurrency B has substantially decreased in value; however, its value was

greater than zero, it continued to be traded on at least one cryptocurrency exchange,
and A did not sell, exchange, or otherwise dispose of the units of Cryptocurrency B.
“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.” Lakewood Assocs. v. Commissioner, 109 T.C. 450, 459 (1997); Treas.
Reg. section 1.165-1; see also Higgins v. Smith, 308 U.S. 473, 475 (1940)
(“[D]eductions are permitted for losses ‘sustained during the taxable year.’ The loss is
sustained when realized by a completed transaction determining its amount.”); United
States v. White Dental Mfg. Co., 274 U.S. 398, 401 (1927) (“The statute obviously does
not contemplate and the regulations forbid the deduction of losses resulting from the
mere fluctuation in value of property owned by the taxpayer.”) (internal citation omitted).

    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 section

2 Special rules apply to casualty, theft, and wagering losses. See sections 67(b)(3), 165(d) and (h), 1231,
and Rev. Rul. 2009-9.
POSTN-114640-22 4

165(a). Whether an asset has become worthless is a question of fact. Boehm v.
Commissioner, 326 U.S. 287, 293 (1945). In the case of a worthless asset, it is not
necessary to relinquish title where there is a “subjective determination of worthlessness
in a given year, coupled with a showing that in such year the asset in question is in fact
essentially valueless.” Echols v. Commissioner, 935 F.2d 703, 708 (5th Cir. 1991). In
Morton v. Commissioner, the Board of Tax Appeals explained that “[t]he ultimate value
of stock, and conversely its worthlessness, will depend not only on its current liquidating
value, but also on what value it may acquire in the future through the foreseeable
operations of the corporation. Both factors of value must be wiped out before we can
definitively fix the loss.” 38 B.T.A. 1270, 1278 (1945).

   In MCM Investment Management, LLC v. Commissioner, the Tax Court applied

the tests articulated in Echols and Morton to determine whether a partnership interest
was worthless and allowed a claimed loss deduction under section 165. T.C. Memo.
2019-158 at 26-31, 62 (citing Echols, 935 F.2d at 708; Morton, 38 B.T.A. at 1278).
The Tax Court found that the petitioner 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. Id. at 28-29, 31-32. Because the petitioner could recover
nothing for its partnership interest upon liquidation of the partnership and because there
was no potential future value due to the third-party subordinated debt agreements at
issue, the Tax Court determined that the partnership interest was worthless. Id. at 58,
62.

    In this case, each unit of Cryptocurrency B had liquidating value, though it was

valued at less than one cent at the end of 2022.3 Cryptocurrency B continued to be
traded on at least one cryptocurrency exchange, allowing for the possibility that it may
increase in value in the future. Accordingly, Cryptocurrency B was not wholly worthless
during 2022 as a result of its decline in value, and Taxpayer A did not sustain a bona
fide loss under section 165(a) in 2022 due to worthlessness.

Abandoned Cryptocurrency

    Under Treas. Reg. section 1.165-2(a), a taxpayer sustains a loss under section

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.” Franklin v.
Commissioner, T.C. Memo. 2020-127 at *18 (citing Treas. Reg. section 1.165-2(a)).

3 As of January 1, 2023, fifteen cryptocurrencies valued at less than one cent per unit were actively traded

with market caps ranging from approximately $77 million to over $4.4 billion along with 24-hour trading
volume ranging from $833,000 to $92 million. See www.coinmarketcap.com for cryptocurrency market
values.
POSTN-114640-22 5

    Taxpayer A did not take any action to abandon and permanently discard

Taxpayer A’s units of Cryptocurrency B during 2022. 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.
See Massey-Ferguson, Inc. v. Commissioner, 59 T.C. 220, 225 (1972) (citing Boston
Elevated Railway Co. v. Commissioner, 16 T.C. 1084, 1108 (1951), aff’d, 196 F.2d 923
(1st Cir. 1952)). “The mere intention alone to abandon is not, nor is non-use alone,
sufficient to accomplish abandonment.” Beus v. Commissioner, 261 F.2d 176, 180 (9th
Cir. 1958), aff’g 28 T.C. 1133 (1957). Some express manifestation of abandonment is
required when the asset is an intangible property interest. Citron v. Commissioner, 97
T.C. 200, 209–10, 213 (1991) (finding that taxpayer abandoned a partnership interest
when the limited partners voted to dissolve the partnership, directed that a final
partnership return be filed, and treated partnership property as no longer belonging to
the limited partners).

    In this case, Taxpayer A maintained ownership of Cryptocurrency B 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. Taxpayer A retained the ability to sell, exchange, or
otherwise dispose of Cryptocurrency B during 2022. Furthermore, Taxpayer A
continued to exert dominion and control over Cryptocurrency B and, regardless of
intent, did not take any affirmative steps to abandon the property during 2022.
Therefore, Taxpayer A did not sustain a loss pursuant to section 165(a) in 2022 due to
abandonment.4

    If you have any questions, please contact Morgan Lawrence at (202) 317-7011.

                                         Sincerely,



                                         _________________________
                                         Ronald J. Goldstein
                                         Senior Technician Reviewer, Branch 2
                                         (Income Tax & Accounting)

4 Because Taxpayer A did not take any action to abandon and permanently discard Cryptocurrency B, we

need not discuss other requirements for a section 165 loss deduction, including the first two prongs set
forth in Treas. Reg. section 1.165-2(a).