The January Effect: The US Internal Revenue Service Rules On Cryptocurrency Loss Harvesting

• Jurisdiction: United States,Federal
• Law Firm: Mayer Brown
• Subject Matter: Technology, Fin Tech
• Author: Mr Mark Leeds
• Published date: 26 January 2023

Janus, the two-headed Roman deity for whom the month January is named, could see the past and the future but not the present. The US Internal Revenue Service ("IRS") must have been inspired by Janus when thinking about cryptocurrencies recently. On one hand, the IRS looked back to 2022 and issued puzzling but adverse guidance for individuals who were crushed in the cryptocurrency meltdown.¹Looking forward, the IRS postponed broker reporting for cryptocurrency transactions until after it issues final regulations on this topic.² This Legal Update will explore both of these developments.

I. CCA 202302011

CCA 202302011 provides a relatively simple fact pattern. An individual investor purchases an on-exchange fungible digital token for $1.00 in 2022. After the cryptocurrency meltdown, the token is worth less than $.01 at year-end but is still traded on at least one cryptocurrency exchange. The taxpayer did not undertake any overt acts indicating that he abandoned the cryptocurrency. The taxpayer claims a tax loss for the diminution in value on his 2022 tax return on the theory that the token is either worthless or that he abandoned the token. There is no discussion as to whether the taxpayer was "gated," that is, there is no discussion as to whether the exchange suspended redemptions so that the taxpayer was unable to sell the token.³ It's worth noting that the "market price" is indicative of value only if the token can be sold. If the exchange is gated, the "market price" is pretty much illusory.

A. A Fool's Errand

One has to wonder what prompted the IRS to issue the CCA in the first place. As we'll explore below, the IRS considered two avenues that a taxpayer have could have considered in generating a 2022 tax loss from the extreme diminution in the value of the cryptocurrency'worthlessness and abandonment. But deductions for both of these events are suspended through the end of 2025.⁴ Accordingly, even if the taxpayer had been successful in establishing either worthlessness or abandonment, he would not have obtained any tax benefit. So why the IRS bothered considering these issues is a mystery. In each case, the taxpayer would be better off taxwise by sitting tight in 2022 and actually selling the depreciated cryptocurrency in 2023.

B. Worthlessness

Code ' 165(a)⁵ provides a deduction for losses sustained during a year, provided that the loss is not compensated by insurance or otherwise. Treasury Regulation ' 1.165-1(d)(1) states that the loss must be evidenced by closed and completed transactions evidenced by...