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IRS Updates Guidance on Virtual Currency Transactions

Commentary by Mark Howe and Steven Lofchie

The IRS provided updated guidance in the form of a revenue ruling and a FAQ on the tax treatment of virtual currency transactions.

The prior guidance, which was released in 2014, stated that virtual currencies are considered property for federal tax purposes, pursuant to the general principles of tax law. New Rev. Rul. 2019-24 and the FAQ address (i) when a cryptocurrency on a distributed ledger undergoes a protocol change that permanently divides the legacy from the existing distributed ledger (i.e., a "hard fork") and (ii) when units of a cryptocurrency are delivered to the distributed ledger addresses of multiple taxpayers (i.e., an "airdrop"), typically following a hard fork.

The IRS requested feedback on whether additional guidance is necessary.

The IRS noted that it is actively pursuing potential instances of noncompliance concerning virtual currency transactions through, among other things, taxpayer education initiatives, audits and criminal investigations.

Commentary

This new guidance (Rev. Rul. 2019-24 and updated FAQ) reaffirms that cryptocurrency is an item of property subject to the normal tax rules involving cost basis, realization and valuation. The guidance illustrates that while the substantive tax issues are not difficult, effort is needed in understanding the technology and the terminology associated with technology. The guidance also reaffirms that the greater challenges will be in tracking and recording transactions in virtual currency.

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Commentary

For those hoping that cryptocurrencies may come into wider use, the IRS's affirmation of its existing guidance is bad news, even if expected. It means that the purchase of a cryptocurrency and the subsequent use of that cryptocurrency to purchase an asset constitutes a taxable event; i.e., that a positive change in the value of the cryptocurrency between the time of its purchase and the time of its use would be taxable. This tax treatment would not be problematic for a "stablecoin" linked to the dollar, as its value would be fixed at a dollar, and thus there would be no profit. However, it is problematic not only for purely virtual currencies such as bitcoin, but also for currencies such as Libra that would be, like stablecoins, backed by "hard assets," but the value of which assets would float relative to the dollar, and thus which could generate taxable profits when spent.

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