IRS Publishes Crypto Advice for Sunken Tokens

The crypto winter is sadly upon us and this means that many crypto holders around the world are seeing their beloved tokens lose value, whether by a little or by a lot. But besides the loss in investment, there is the unique problem of how these tokens should be treated in terms of tax filings.

Luckily, the Internal Revenue Service (IRS) has put out an advisory to offer help with dealing with tokens that have lost their value. The document is titled “[a]pplicability of I.R.C. section 165 to cryptocurrency that has declined in value.” and focuses on how section 165 of the Internal Revenue Code should be applied to such tokens. 

Dealing with Sunken Tokens

The basis of this advisory was the IRS trying to address the question of “[i]f 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?”

In the document, the IRS went on to clarify what qualifies as a worthless or abandoned cryptocurrency. To illustrate, the IRS used the example of a hypothetical ‘cryptocurrency B’ which was bought on a crypto exchange for $1 per unit by taxpayer A but by the end of 2022, was trading for less than 1 cent. 

However, the advice noted that cryptocurrency B would not be deemed worthless in this case because it still has a value above zero and continued to be traded on exchanges. This means, the document says, that there is still a chance for the asset to increase in value in the future.

“‘[1.] the mere diminution in value of property does not create a deductible loss[, 2. a]n economic loss in value of property must be determined by the permanent closing of a transaction with respect to the property [and, 3. a] decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as abandonment, sale, or exchange.’” it says. 

In terms of the token being abandoned, the IRS determined that because the taxpayer still retains the right to sell, exchange, or otherwise dispose of Cryptocurrency B during 2022 and did not take active steps to abandon it, they cannot be said to have suffered a loss. 

Again, all these have to do with Section 165 which allows taxpayers to claim losses on their assets. However, the document explains that if a cryptocurrency is similar to cryptocurrency B in that it does not count as worthless or abandoned, losses cannot be claimed on it. 

“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,” the document says. 

And while the IRS notes that this advice should not be taken as a precedent, it does shed more light on how cryptos could potentially be treated by the authorities.