Historically, U.S. tax law has allowed a taxpayer to exchange one investment property for another and defer the income tax consequences of that exchange so long as both the relinquished property and the acquired property are sufficiently similar—along with several other requirements. This type of tax-deferred exchange is referred to as a Like-Kind or Section 1031 Exchange. Without this Like-Kind Exchange treatment, a taxpayer would owe income tax on the increase in value of the relinquished property at the time it was exchanged for the acquired property.
Real estate, artwork, aircrafts, and coin collections, held for business or investment purposes, are examples of types of property that have qualified for Like-Kind Exchange treatment.
The IRS’s 2014 income tax guidance on cryptocurrencies (or what the IRS refers to as virtual currencies) indicated that the exchange of a cryptocurrency for other property would trigger a capital gain or loss, as applicable, at the time of exchange. The guidance clearly covered the use of cryptocurrencies to pay for goods. Commentators questioned, however, whether Like-Kind Exchange treatment was possible when one cryptocurrency was exchanged for another cryptocurrency if the cryptocurrencies involved were sufficiently similar.
This question was answered somewhat when the recently enacted Tax Cuts and Jobs Act restricted Like-Kind Exchange treatment to only real estate exchanges beginning in 2018 going forward. But the question remained open for pre-2018 exchanges of cryptocurrencies.
On November 15, 2019, Christopher Wrobel, special counsel to the IRS associate chief counsel stated, “[f]or pre-2018 years, we would not say necessarily that cryptocurrency is automatically not eligible for 1031 treatment.” He went on to say that, like any other asset, exchanges of cryptocurrency would be evaluated under section 1031 on a case-by-case basis. “You’d have to look at the individual transaction level to make a determination under 1031.”
These statements are welcome news for U.S. taxpayers with potential income tax liabilities on exchanges of cryptocurrencies before 2018, particularly in light of the IRS’s recent announcement that it had begun sending letters to taxpayers who may have failed to properly report income and pay any tax associated with cryptocurrency.
U.S. taxpayers who engaged in cryptocurrency exchanges should consider whether Like-Kind Exchange treatment is available for their pre-2018 transactions.