In January, the Chief Counsel’s Office of the IRS issued Advice Memorandum CCA 202302011,[1] explaining how and when a taxpayer may deduct crypto losses as “worthless or abandoned” property under Section 165(a) of the Internal Revenue Code. It is important to note that, under current law, Section 67(g) of the Code currently disallows all such losses for tax years beginning after December 31, 2017 and before January 1, 2026, so one wonders why the Service determined this guidance was needed now.
According to the Advice Memorandum, if the value of cryptocurrency has declined, but it is still trading on at least one exchange, and the taxpayer has not sold, exchanged, or otherwise disposed of its units, the taxpayer cannot deduct the loss, because the taxpayer continues to control the crypto (which is still trading) and the crypto has some value remaining. Moreover, the prospect exists of the crypto acquiring additional value in the future.
Deductibility
Section 165(a) permits a deduction from ordinary income (as opposed to capital gains) for losses that are not compensated for by insurance or otherwise, if the losses are “sustained” during the taxable year, meaning the losses are “evidenced by closed and completed transactions, fixed by identifiable events.”[2] In order to be entitled to the loss deduction, the taxpayer must be able to demonstrate that the asset has no current liquidity value and no prospect of acquiring such value, although the taxpayer need not have “relinquished title” to the property (e.g. relinquished ownership).[3]
Section 165 does not explicitly mention abandonment losses, but numerous case law decisions address loss from abandonment, and Code Regulation 1.165-2 governs deductibility of losses from obsolescence of non-depreciable property, where such property is permanently discarded from use.
Worthlessness
According to case law and regulations, an economic loss in value must be accompanied by some affirmative step that fixes the amount of the loss.[4] With regard to crypto assets, to demonstrate worthlessness, perhaps a taxpayer could offer the crypto for sale and demonstrate that no offers were received at any price. One questions whether this would qualify as an “identifiable event,” however. A qualified appraisal of zero value could potentially suffice to prove worthlessness.
However, the Advice Memorandum does not explain how a taxpayer could prove that there is no prospect that the crypto could regain value. Proving a negative is notoriously difficult. One commentator has suggested that the only possibility would be to show that the blockchain on which the assets were recorded was no longer active, but how could the taxpayer show the blockchain had no prospect of becoming active once again? An adjudication of a legal claim or a settlement of such a claim probably could adequately demonstrate a final determination of loss and concurrently prove the amount of the loss. It seems that a taxpayer would have to go to court to obtain such evidence of loss.
Abandonment
The Advice Memorandum expressly states that abandonment is proven through an evaluation of the surrounding facts and circumstances, which must show intent to abandon coupled with an affirmative act of abandonment.[5] Tangible property can be abandoned physically, by hauling the property to the dump, for example, but abandonment of intangible property can only be established, practically speaking, by detailed documentation.
Perhaps the best way to demonstrate loss by abandonment would be to show abandonment of any claim for reimbursement of the crypto loss. Code Regulation 1.165-1(d)(2) provides that a taxpayer may demonstrate a loss by proving abandonment of any claim for reimbursement of the loss during the taxable year in question. To show such abandonment of a claim, the taxpayer must be able to produce objective evidence, such as the execution of a valid, legal release of the claim. The value of the abandonment loss must also be demonstrated via documentation showing the initial purchase price together with subsequent documentation of the value of the property at the time any claim has been effectively abandoned. How would a taxpayer show abandonment of any claim for reimbursement, if no such claim ever existed?
If a taxpayer cannot demonstrate abandonment of any claim for reimbursement, can the taxpayer prove abandonment of the actual crypto asset, itself? What affirmative act to permanently discard the intangible asset will suffice? In Revenue Ruling 2004-58, The Office of Chief Counsel stated that the act of abandonment must be observable to outsiders and constitute some step which irrevocably cuts ties to the asset.[6]
The IRS has made it clear that reporting regarding crypto assets will be a focus of its audits of taxpayer returns. Guidance regarding how taxpayers could effectively substantiate claims for crypto losses due to worthlessness or abandonment would be a meaningful way to allow, and in fact encourage, taxpayer compliance.
[1] Advice Memorandum CCA 202302011 (Jan. 10, 2023) https://www.irs.gov/pub/irs-wd/202302011.pdf
[2] Id.
[3] Id.
[4] Id.
[5] Id., citing Massey Ferguson, Inc. v. Commissioner, 59 T.C. 220, 225 (1972).
[6] Rev. Rul. 2004-58, citing United Dairy Farmers, Inc. v. U.S., 267 F.3d 510, 522 (6th Cir. 2001) (quoting Corra Resources, Ltd. V. Commissioner, 945 F. 2d 224, 226 (7th Cir. 1991). Rev. Rul. 2004-58, 2004-1 CB 1043.