Bitcoin, Ether, and Litecoin exchanges were not like kind

Plain-English summary

Chief Counsel considered whether exchanges among Bitcoin, Ether, and Litecoin completed before 2018 qualified for nonrecognition under the former personal-property version of Section 1031. It concluded that none of the three pairs were like-kind property. Bitcoin and Ether differed from Litecoin because they served as primary routes between fiat currency and other cryptocurrencies during 2016 and 2017, while Litecoin had much more limited trading-pair availability. Bitcoin and Ether also differed from each other because Bitcoin was designed mainly as a payment network, while Ethereum supported smart contracts and applications and used Ether as their fuel. The advice is limited to these three cryptocurrencies and does not address other digital assets.

Ruling snapshot

• Question: Before 2018, did exchanging Bitcoin, Ether, or Litecoin for one another qualify as a Section 1031 like-kind exchange?
• Outcome: Advice given: no for Bitcoin-Ether, Bitcoin-Litecoin, and Ether-Litecoin exchanges.
• Key authorities: IRC § 1031(a)(1); Treas. Reg. § 1.1031(a)-1(b); Rev. Rul. 79-143; Rev. Rul. 82-166

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 202124008
Release Date: 6/18/2021
CC:ITA:B04:JYu
PRENO-112294-21

UILC: 1031.00-00, 1031.02-00

date: June 08, 2021

 to:   Michael Fiore

Area Counsel
(Small Business/Self-Employed)

from: Ronald J. Goldstein
Senior Technician Reviewer, Branch 4
(Income Tax & Accounting)

subject: Applicability of Section 1031 to Exchanges of Bitcoin (BTC) for Ether (ETH), Bitcoin
for Litecoin (LTC), and Ether for Litecoin

This responds to your request for non-taxpayer specific advice regarding the
applicability of § 1031 of the Internal Revenue Code (“Code”) to exchanges of certain
cryptocurrencies completed prior to January 1, 2018.

                                       ISSUE

If completed prior to January 1, 2018, does an exchange of (i) Bitcoin for Ether, (ii)
Bitcoin for Litecoin, or (iii) Ether for Litecoin qualify as a like-kind exchange under
§ 1031 of the Code?

                                   CONCLUSION

No. If completed prior to January 1, 2018, an exchange of (i) Bitcoin for Ether, (ii)
Bitcoin for Litecoin, or (iii) Ether for Litecoin does not qualify as a like-kind exchange
under § 1031 of the Code.

                                  BACKGROUND

Virtual currency is a digital representation of value that functions as a medium of
exchange, a unit of account, or a store of value other than a representation of the U.S.
dollar or a foreign currency. Notice 2014-21; Rev. Rul. 2019-24. Virtual currency that
has an equivalent value in real currency, or acts as a substitute for real currency, such
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as Bitcoin, is referred to as “convertible” virtual currency and is considered property for
federal income tax purposes. Notice 2014-21. Accordingly, general tax principles
applicable to property transactions apply to transactions involving convertible virtual
currency. Id.

Bitcoin, Ether, and Litecoin are all forms of cryptocurrency, a type of virtual currency
that utilizes cryptography to secure transactions that are digitally recorded on a
distributed ledger, such as a blockchain. Rev. Rul. 2019-24 at 2. Distributed ledger
technology uses independent digital systems to record, share, and synchronize
transactions, the details of which are recorded in multiple places at the same time with
no central data store or administration functionality. Id. Cryptocurrencies may be used
as a method of payment; however, many taxpayers transact in cryptocurrency for
investment or other purposes.

Cryptocurrency exchanges are digital platforms that allow users to trade one
cryptocurrency for another cryptocurrency, as well as for fiat currencies such as the
U.S. dollar. The possible combinations supported by the exchange are known as
trading pairs. Major cryptocurrencies like Bitcoin and Ether typically may be traded for
any other cryptocurrency and vice versa. However, some cryptocurrencies on a
cryptocurrency exchange can be traded for only a limited number of other
cryptocurrencies and cannot be traded for fiat currency at all. For example, one popular
cryptocurrency exchange supported more than 30 different cryptocurrencies, but almost
all of them could be acquired with or traded for only Bitcoin, Ether, or fiat currency. In
2017, there were more than 1,000 different cryptocurrencies in existence.

                        DISCUSSION

Section 1031(a)(1) of the Code provides that no gain or loss shall be recognized on the
exchange of property held for productive use in a trade or business or for investment if
such property is exchanged solely for property of like-kind which is to be held either for
productive use in a trade or business or for investment. The nonrecognition of gain or
loss under § 1031 is intended to apply to transactions where the taxpayer's economic
situation following the exchange is essentially the same as it had been before the
transaction. H. Rept. 704, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 554, 564.
The Tax Cuts and Jobs Act, P.L. 115-97, amended § 1031 to limit like-kind exchange
treatment after December 31, 2017, to exchanges of real property. Prior to 2018,
section 1031 also applied to certain exchanges of personal property.

Treas. Reg. § 1.1031(a)-1(b) defines “like kind” to mean the nature or character of the
property and not the grade or quality. One kind or class of property may not be
exchanged for property of a different kind or class. For example, an investor who
exchanged gold bullion for silver bullion was required to recognize gain in part because
silver is primarily used as an industrial commodity while gold is primarily used as an
investment. Rev. Rul. 82-166. Similarly, an investor who exchanged one kind of gold
coin for another kind of gold coin was required to recognize a gain because one coin’s
PRENO-112294-21 3

value was derived from its collectability while the other’s value was derived from its
metal content. Rev. Rul. 79-143.

   BTC/LTC and ETH/LTC

In 2016 and 2017, Bitcoin, and to a lesser extent Ether, held a special position within
the cryptocurrency market because the vast majority of cryptocurrency-to-fiat trading
pairs offered by cryptocurrency exchanges had either Bitcoin or Ether as part of the
pair. In other words, an individual seeking to invest in a cryptocurrency other than
Bitcoin or Ether, such as Litecoin, would generally need to acquire either Bitcoin or
Ether first. Similarly, an individual seeking to liquidate his or her holdings in a
cryptocurrency other than Bitcoin or Ether, such as Litecoin, generally would need to
exchange those holdings for Bitcoin or Ether first. In contrast, Litecoin’s trading pair
availability at the time was substantially more limited.

Thus, Bitcoin and Ether played a fundamentally different role from other
cryptocurrencies within the broader cryptocurrency market during 2016 and 2017.
Unlike other cryptocurrencies, Bitcoin and Ether acted as an on and off-ramp for
investments and transactions in other cryptocurrencies. Because of this difference,
Bitcoin and Ether each differed in both nature and character from Litecoin. Therefore,
Bitcoin and Litecoin (BTC/LTC) do not qualify as like-kind property for purposes of
section 1031; nor do Ether and Litecoin (ETH/LTC).

   BTC/ETH

As discussed above, Bitcoin and Ether shared a special role in the cryptocurrency
market that made them fundamentally different from Litecoin during the relevant years.
However, while both cryptocurrencies share similar qualities and uses, they are also
fundamentally different from each other because of the difference in overall design,
intended use, and actual use. The Bitcoin network is designed to act as a payment
network for which Bitcoin acts as the unit of payment. The Ethereum blockchain, on the
other hand, was intended to act as a payment network and as a platform for operating
smart contracts and other applications, with Ether working as the “fuel” for these
features. Thus, although Ether and Bitcoin may both be used to make payments,
Ether’s additional functionality differentiates Ether from Bitcoin in both nature and
character. Therefore, Bitcoin and Ether do not qualify as like-kind property under
section 1031.

                       CONCLUSION

If completed prior to January 1, 2018, an exchange of (i) Bitcoin for Ether, (ii) Bitcoin for
Litecoin, or (iii) Ether for Litecoin does not qualify as a like-kind exchange under § 1031.

This chief counsel advice is limited to the exchanges involving Bitcoin, Ether, or Litecoin
discussed above. This chief counsel advice does not address any other
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cryptocurrencies, or any other analyses not discussed in this advice. Accordingly, no
inferences should be made based on this chief counsel advice that are not explicitly set
forth in this advice.

This chief counsel advice may not be used or cited as precedent.

Please contact James Yu at (202) 317-4718 if you have any further questions.