Are the DOJ and IRS backpedaling on considering cryptocurrency as property? – Accounting Today

The Department of Justice made a startling claim in a legal filing last week that cryptocurrencies or virtual currencies are not in all instances property for U.S. tax purposes.

The DOJ filed a formal answer on Aug. 27 to a complaint from Joshua and Jessica Jarrett, which they filed May 26 with a Tennessee federal district court (Case No. 3:21-cv-00419), seeking a refund of taxes they had paid in connection with their generation of Tezos digital tokens through their proof-of-stake activities.

By way of background, in 2014 the IRS issued Notice 2014-21, which was the agencys initial official guidance on the treatment of transactions involving virtual currencies. Using a FAQ approach, the IRS provided that virtual currencies are property and not fiat currency:

Q-1: How is virtual currency treated for federal tax purposes? A-1: For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency."

"Q-2: Is virtual currency treated as currency for purposes of determining whether a transaction results in foreign currency gain or loss under U.S. federal tax laws? A-2: No. Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.

In Revenue Ruling 2019 24 and additional FAQs posted on the IRS website at the same time in 2019, the IRS provided further guidance as to the treatment of virtual currencies. Q&A 2 in the FAQs posted on the IRS website reiterates what was stated in Q&A 1 in Notice 2014-31, which is that virtual currencies are property for U.S. tax purposes.

So, lets go back to the IRSs formal answer to the legal complaint from the Jarretts. In Item 30, responding to Paragraph 30 of the complaint, the Jarrets stated, Virtual currency is property for purposes of U.S. federal tax law. Given Notice 2014-21 and Q&A 2 of the FAQs, this statement would not have been expected to generate any controversy.

However, the DOJ response was that Paragraph 30 states a legal conclusion and that to the extent a response is required, the United States denies that virtual currency is in all instances property for the purpose of U.S. tax law. This statement directly contradicts Notice 2014-31 and the FAQs currently posted on the IRS website, and raises a number of questions.

One interpretation of this denial is that in the view of the DOJ and the IRS, despite the prior guidance to the contrary, virtual currencies can now be classified as something other than property or fiat currency and instead could fall into some third category. It is very unclear as to what that third category could be.

Another interpretation is that virtual currencies should be treated as fiat currency in some cases. If that is the case, then presumably the virtual currencies would be classified as a foreign currency since they are not U.S. dollars, such that the foreign currency provisions of Section 988 would apply. Note that under Section 988, foreign currency gains are generally taxed at ordinary income rates, not at capital gains rates. If Section 988 applies, could active traders take the position that a particular cryptocurrency is the functional currency for their trade or business? Does the $200 per transaction involving foreign currency held for personal use apply? Classifying virtual currencies as fiat currency likely raises far more questions and creates far more uncertainty than classifying them as property.

Time will tell as the DOJ addresses this issue in more detail in the pending litigation. Hopefully, any additional guidance will provide clarity rather than additional confusion and complications for holders of virtual currencies.

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Are the DOJ and IRS backpedaling on considering cryptocurrency as property? - Accounting Today