Anyone who sticks with cryptocurrency investing long enough will eventually find themselves holding worthless or nearly worthless coins. Altcoins of limited utility will simply fail to catch on, or developers will disappear, or the market will fail to show favor to an obviously useless meme coin. In almost all cases, worthlessness will coincide with the loss of exchange support, effectively cancelling any ability for users to properly dispose of their holdings without directly finding a buyer (and who buys worthless coins?). This leaves the holder with only two options from a tax perspective- either treat the coins as “abandoned” and claim an ordinary loss, or treat them as “worthless” for a capital loss. Recent guidance from the IRS reinforces the importance of a fact-centric analysis in determining which position to take.
According to a recently issued Chief Counsel Advice (CCA), a taxpayer whose cryptocurrency had substantially declined in value didn’t sustain a deductible loss due to the worthlessness or abandonment of the cryptocurrency. The taxpayer purchased coins for $1 per unit as a personal investment. Later, the value fell until it was worth less than $.01 per unit. The taxpayer claimed a loss on their tax return, taking the position that the investment was either worthless or abandoned. Under audit, the Chief Counsel determined that the deduction should be disallowed. While IRC Sec. 165 does allow a deduction for worthless securities, cryptocurrency is not a security (except when it is). The coins in question also couldn’t be considered worthless because they continued to be traded on at least one exchange at a value of greater than $0.
We don’t know why this taxpayer claimed the loss without attempting to sell or why they didn’t take the position of having abandoned the asset (though a capital loss would clearly be better in some instances). Since the position the taxpayer actually took did not meet the criteria for either worthlessness or abandonment, they received the benefit of neither of those positions. It is worth noting here that we have very little indication as to what a proper “abandonment” of cryptocurrency would even look like from the perspective of the IRS. What we do know is the IRS seems to be holding fast to the position that any part of the Internal Revenue Code which could be readily applied to cryptocurrency will not be so applied in the absence of specific language allowing such a position, even when the outcome is a result that is stupid or needlessly harmful to taxpayers.
There is a lot more to all of this. Suffice to say that careful consideration informed by professional guidance is always a great idea prior to taking an uncertain tax position.