IRS Taxation Ruling Demystified -- Like-Kind is the Kind we'd Like

The only sure bulwark of continuing liberty is a government strong enough to protect the interests of the people, and a people strong enough and well enough informed to maintain its sovereign control over the goverment.
~Franklin D. Roosevelt~

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"Like-Kind" Like Im Five

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The topic of this post involves new legislation introduced by Page 762 of The New Tax Bill Recently Passed which has modified all gains received through cryptocurrency exchanges to no longer be classified as 1031 exchanges of ‘Like-Kind’ property. To provide some background on property exchanges, I have provided examples below. If you are already familiar with the tax treatment of property exchanges, feel free to skip past the examples.

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Example 1 (Basic Sale of Property):

John buys a factory for $100,000 (this cost establishes John’s ‘basis’ on the property) on 1/1/2015. On 1/1/2018, John decides to sell the factory for $150,000. As the sale price is $50,000 more than John’s basis ($150,000 - $100,000), John realizes a gain (or income) of $50,000. This $50,000 gain is recognizable in the eyes of the IRS as taxable income for year of sale (1/1/2018).

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Example 2 (‘Like-Kind’ Exchange of Property):

Using the same fact pattern as Example 1, assume that instead of pocketing the $50,000 additional income received from the sale, John decides to use the gain to purchase another factory in 2018, which is worth $170,000. Thus, John uses his return of investment/basis ($100,000), the gain from sale ($50,000), and an additional $20,000 to purchase the new factory. As this is a ‘Like-Kind’ exchange of property, the recognition of the $50,000 gain is added into the new property and deferred (along with the related tax liability) until the new factory is sold. Thus, during 2018, John would not recognize a tax liability related to the transaction.
Further explanation of how the sale of the new factory is treated if sold for $180,000 (assume the sale of Factory #2 occurs 1/1/2019):

• John’s Adjusted Basis = $120,000 (initial investment of $100,000 + $20,000).
  o Note: The new basis does not include the $50,000, because the gain of $50,000 is not recognized when the second factory is purchased.
• Recognized Gain (or Income) = $60,000 ($180,000 Sale Price - $120,000 Basis)
  o Note: This results in a tax liability for the year 2019.

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Example 3 (Non-Deferred Exchange of Property):

Using the same fact pattern as Example 2, assume that instead of purchasing another factory for $170,000, John purchases an airplane. As this transaction is not considered ‘Like-Kind’ per 1031 criteria, the $50,000 is NOT deferred and is, instead, recognized in the year the initial factory is sold.
Further explanation/breakdown of the sale follows:

• John’s Basis = $100,000
  o Note: No additional money was invested in “like-kind” property after the initial purchase of $100,000.
• Recognized Gain (or Income) = $50,000 ($150,000 Sale Price - $100,000 Basis).
  o Note: This results in a tax liability for the year 2018. It is important to recognize that in Example 2 above, the tax liability is deferred until the second factory is sold, while in this example, the tax liability is established immediately upon exchanging assets.

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The Problem...

As I previously mentioned, the new tax bill modifies gains resulting from cryptocurrency exchanges so that they are no longer treated as 1031 ‘Like-Kind’ exchange gains. In essence, this means that any gain accumulated on Crypto X is recognized immediately when exchanged for Crypto Y (refer to Example 3 above).
In my opinion this is going to impede heavily upon the US crypto markets. As with any other market, taxes reduce the disposable income which is, in turn, used to invest in the market. Thus, every crypto-to-crypto exchange will result in a loss of total money circulating within the marketplace. Additionally, this new legislation discourages the transfer of wealth throughout the crypto markets. Take Bitcoin holders for example. If someone invested in Bitcoin at $0.03/BTC and, at $17,000/BTC, the holder decides to exchange just one BTC for another cryptocurrency, he/she will recognize a gain of $16,999.97, of which is taxable. As such, anyone with a material amount of unrecognized gains on his/her crypto will be forced to hold on to the initial investment.

The new tax bill will affect all transactions occurring after 12/31/2017. Thus, if you are planning to take part in any crypto-to-crypto exchanges, now would be the time to do so. Tax law is not my area of expertise and, as such, any additional insight would be greatly appreciated.

Feel free to ask any questions that you may have in the comments below, I will do my best to answer them. Additionally, I would like to thank all of you for 1) taking the time to read my post and 2) taking action to further progress our community and its understanding as it relates to crypto currency taxation.
Have a wonderful day!

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About Me

My name is Kyle Fondriest. I recently obtained a Masters of Accountancy with a concentration in Information Systems from the University of Tennessee, Knoxville (Go Vols!). I am currently working with Deloitte & Touche, LLP as an Advisory consultant as well as studying for my CPA certification. I write today to begin a series of discussions revolving around what I believe to be a topic of great importance in the Crypto-space: Cryptocurrency Taxation. It is my hope that through these posts we, the crypto community, can gain a better understanding of the effects arising from tax legislation, as well as, provide insight into potential future legislation. Please, don’t hesitate to post your opinions on the subject matter. It is through collaboration that we will achieve our ultimate potential.

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Disclaimer

First, the opinions outlined in this post are my personal opinions and do not, in any way, represent the opinions of Deloitte & Touche. Secondly, I am not a tax specialist, as such, all information presented within this post has been derived from the education obtained while pursuing my Masters in Accountancy and my own individual research.