On July 26, the IRS announced it was sending “educational” letters to more than 10,000 taxpayers that the agency suspects “failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.” Commissioner Charles P. Rettig added that taxpayers “should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties.”
This initiative is somewhat surprising. Commissioner Rettig acknowledged in May that the agency has not yet provided taxpayers with “clarity on basic issues related to the taxation of virtual currency transactions," including fundamental questions such as how taxpayers should calculate the tax basis of their cryptocurrencies and how they should assign those bases to cryptocurrency dispositions. Commissioner Rettig has assured Congress and other stakeholders that substantive guidance will be coming “soon,” although there continues to be no mention of it in the agency’s “Priority Guidance Plan,” which lists “guidance items that are most important to taxpayers and tax administration.”
More surprisingly, perhaps, is that the threelettertemplates the agency released seem to contain answers to some of the open questions about the tax treatment of cryptocurrency transactions that it has failed to articulate in guidance. Two key examples:
- Notice 2014-21 says that “taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.” We have previously noted that requiring fair market value calculations to be conducted using a daily exchange rate, rather than allowing for more precise methodologies, often doesn’t make sense, particularly for virtual currencies that have significant intraday exchange rate movements. The recently released Letters 6174 and 6174-A, however, instruct taxpayers to “report the virtual currency received at its fair market value, measured in U.S. dollars, as of the date and time of the transaction.” (Emphasis added.)
- Section 1031 of the Internal Revenue Code stipulates that no gain or loss need be recognized when certain types of property of “like kind” are exchanged. The Tax Cuts and Jobs Act of 2017 narrowed this exception to only apply to real estate exchanges starting in 2018, but it has been an open question whether or not certain virtual currency transactions that occurred before then would qualify. However, all three of the letters the IRS released—which address tax years 2013 to 2017–state that “an exchange of a virtual currency (such as Bitcoin, Ether, etc.) includes the use of the virtual currency to pay for goods, services, or other property, including another virtual currency such as exchanging Bitcoin for Ether.” The implication is that the IRS does not recognize the “like kind” exemption for cryptocurrencies.
Generally, the letters hint at positive changes in the IRS’ approach to the taxation of virtual currency transactions, albeit changes that should come in the form of formal guidance rather than ominous letters alleging noncompliance.
(For a more in-depth look at what the open questions are as well as suggestions of common-sense clarifying guidance the IRS could provide, please see our report “A Duty to Answer.”)