Do altcoin trades count as like-kind exchanges? (Deferred capital gains tax)

Question

2018 EDIT: Although this post was inspirational, US Congress addressed this issue in the Tax Reform law of 2017, and any trades after Jan 1st 2018 cannot have this treatment. The few years of ambiguity from the existence of altcoins to the law changing will likely never be addressed.

Most altcoins do not have markets in national currencies, and instead can only be bought with other digital currencies.

So therefore by the IRS' own guidance, you are trading property for property. Which in some cases is privy to like-kind treatment where capital gains tax events are no longer created upon liquidation into another like property until settled in a national currency.

IRC Section 1031 provides an exception and allows 
you to postpone paying tax on the gain if you reinvest 
the proceeds in similar property as part of a qualifying like-kind exchange.

The IRS' limitation in unilaterally recognizing currencies or recognizing distinct asset classes has pigeonholed blockchain based digital currency in an area of the law that has many distinct benefits, with the ambiguous designation of property.

The best like-kind guidance that the IRS has attempts to list asset classes which receive like-kind treatment, and also attempts to list asset classes that are SPECIFICALLY NOT ABLE to receive like-kind treatment.

Both properties must be held for use in a trade or business 
or for investment.   Property used primarily for personal use, 
like a primary residence or a second home or vacation home, 
does not qualify for like-kind exchange treatment. 
Both properties must be similar enough to qualify as "like-kind." 
Like-kind property is property of the same nature, character or class.
**Quality or grade does not matter.** 

The IRS has potentially accidentally created a huge tax benefit/loophole for digital currency speculation by a limitation of their own Congressional mandate, where previously in most assets that weren't included in their list (like, say Credit Default Swaps), one could operate under the assumption that the trades were open and closed in national currencies, and therefore subject to capital gains tax.

(Most IRS guidance so far seems based on the assumption that people buy and sell bitcoin - specifically bitcoin - for US dollars, and ignores the notion that there is a parallel burgeoning economy within that ecosystem.)

Would the buying and selling of blockchain based digital currency, using other blockchain based digital currencies, be subject to like kind treatment and exempt from capital gains until exchanged for a non-blockchain based good or service (or national currency)?

Before you say "what? asking people on the internet complicated legal things you should talk to a CPA", you have to understand that both the CPAs and the next pencil pushers in the government who are tasked to this will simply google it and form their opinion based on things that rank highly in SEO, like this exact question will. You'll just have to accept that it hasn't been asked before, and that it is more on topic here than on the bitcoin stackexchange.

Answer 1

No.

Since a change affecting the 2018 tax-year and beyond, Like-Kind Exchanges only apply to real estate.

https://www.irs.gov/newsroom/like-kind-exchanges-now-limited-to-real-property

Answer 2

In June 2016 the American Institute of CPAs sent a letter to the IRS requesting guidance on this question.

Quoting from section 4 of this letter, which is available at https://www.aicpa.org/advocacy/tax/downloadabledocuments/aicpa-comment-letter-on-notice-2014-21-virtual-currency-6-10-16.pdf

If the IRS believes any property transaction rules should apply differently to virtual currency than to other types of property, taxpayers will need additional guidance in order to properly distinguish the rules and regulations.

Section 4, Q&A-1 of Notice 2014-21 states that “general tax principles applicable to property transactions apply to transactions using virtual currency,” which is guidance that is generally helpful in determining the tax consequences of most virtual currency transactions. However, if there are particular factors that distinguish one virtual currency as like-kind to another virtual currency for section 1031 purposes, the IRS should clarify these details (e.g., allowing the treatment of virtual currency held for investment or business as like-kind to another virtual currency) in the form of published guidance. Similarly, taxpayers need specific guidance of special rules or statutory interpretations if the IRS determines that the installment method of section 453 is applied differently for virtual currency than for other types of property.

So, at the very least, a peer-reviewed committee of CPAs finds like-kind treatment to have possible grounds for allowance.

I would disagree with calling this a "loophole," however (edit: at least from the viewpoint of the taxpayer.) At a base technological level, a virtual currency-to-virtual currency exchange consists of exchanging knowledge of one sequence of binary digits (private key) for another. What could be more "like-kind" than this?

Answer 3

Like-kind of exchanges have a list of requirements.

• Must be for investment or business purposes
• Must not be trade inventory
• Must be very, very similar

The IRS has not issued formal guidance in the matter.

I recommend to be aggressive and claim the exchange, while justifying it with a good analogy to prove good faith (and persuade the IRS official reading it the risk of losing in tax court would be to high).

Worst case the IRS will attempt to reject the exchange, at which point you could still pony up to get rid of the problem, interest being the only real risk.

For example: Past tax court rulings have stated that collectable gold coins are not like kind to gold bars, and unlike silver coins, but investment grade gold coins are like kind to gold bars. So you could use a justification like this: I hold Bitcoin to be like-kind to Litecoin, because they use the same fundamental technology with just a tweak in the math, as if exchanging different grades of gold bars, which has been approved by tax court ruling #xxxxx. Note that it doesn't matter whether any of this actually makes sense, it just has be reasonable enough for you to believe, and look like it is not worth pursuing to an overworked IRS official glancing at it.

I haven't tried this yet, so up to now this is a guess, but it's a good enough guess in my estimation that I will be using it on some rather significant amounts next year.

Answer 4

Just a thought because this is a really good question:

Would the buying and selling of blockchain based digital currency, using other blockchain based digital currencies, be subject to like kind treatment and exempt from capital gains until exchanged for a non-blockchain based good or service (or national currency)

Suppose someone sells 1 bitcoin to buy 100 monero. Monero's price and bitcoin's price then change to where the 100 monero are 3 bitcoins. The person gets their bitcoin back and has 66.67 monero remaining.

This scenario could be:

Suppose someone sells 1 bitcoin at $1000 to buy 100 monero at $10. Bitcoin crashes 80% to $200 while monero crashes to only $6 per monero. $6 times 100 is $600 and if the person gets their bitcoin back (at $200 per bitcoi), they still lost money when measured in US Dollars if they move that bitcoin back to US dollars.

In reading the IRS on bitcoin, they only care about the US dollar value of bitcoin or monero and in this example, the US dollar value is less. The person may have more bitcoins, but they still lost money if they sell.