7722 / When is the fair market value of bitcoin used in a sale or exchange transaction determined?

For purposes of determining the value of bitcoin received that must be included in gross income, the fair market value is determined as of the date the bitcoin is received by the taxpayer. As in other property transactions, this fair market value forms the “basis” of the bitcoin as of that date.¹ The taxpayer must determine the value of the bitcoin in U.S. dollars. This means that the basis of bitcoin will typically be its acquisition cost. In the case of a gift or inheritance of bitcoin, the basis of the bitcoin in the hands of the donor will presumably apply (this issue has not yet² been formally addressed in official guidance).

Planning Point: As of early 2022, proposals would require taxpayers to report cryptocurrency transactions with a fair market value of $10,000 or more. Beginning January 1, 2024, these cryptocurrency transactions will trigger Form 8300 filing requirement if the fair market value of the transaction is $10,000 or more.

In some cases, virtual currency such as bitcoin will be listed on an exchange, in which case the exchange rate listed on that exchange must be used to convert the value into U.S. dollars (or some other “real” legal tender currency that can be converted to U.S. dollars).

Late in 2019, the IRS released a set of FAQ answering questions about the tax treatment of bitcoin and other virtual currency. One issue that commonly arose was determining how exchanges of virtual currency for other virtual currency or property were taxed. The FAQ provide that when virtual currency is exchanged for other virtual currency, the taxpayer’s gain or loss is the difference between the fair market value of the currency received and the adjusted basis of the property disposed of. If the property exchanged is a capital asset, capital gain or loss tax treatment will apply. If the property exchanged is not a capital asset, ordinary income tax treatment will apply.

Planning Point: The IRS Office of Chief Counsel (OCC) released a Chief Counsel Advice (CCA) document advising that a charitable contribution deduction for a donation of digital assets without a qualified appraisal should be denied because the value of those assets exceeded $5,000. The taxpayer in this case donated cryptocurrency valued at $10,000. The $10,000 value was based on the value listed on the cryptocurrency exchange where the assets were purchased as of the date the donation was made. The taxpayer did partially complete Form 8283, Noncash Charitable Contributions, but did not obtain a qualified appraisal. The IRS did not agree with the taxpayer's rationale that she did not need an appraisal because the value of the digital assets was published and readily available. Under IRC Section 170(f)(11)(C), an appraisal is generally not required when the property has readily available value (including cash, publicly traded securities, etc.). The OCC noted that while cryptocurrency exchanges may publish valuation information, these assets do not meet the definition of a security. The IRS further found that a reasonable cause exception would not apply because the taxpayer did not attempt to obtain an appraisal as required in Form 8283. However, the OCC also noted that the CCA should not be cited as precedent.³

When a taxpayer receives virtual currency through an exchange, the fair market value is the amount recorded by that exchange in U.S. dollars. If virtual currency is received in a peer-to-peer transaction, fair market value is determined as of the date and time the transaction is recorded on the distributed ledger. The IRS notes that it will accept as evidence of fair market value certain values determined by a cryptocurrency or blockchain explorer that analyzes worldwide virtual currency values. If the taxpayer does not use an explorer value, the taxpayer is responsible for establishing that the value used is an accurate reflection of the virtual currency’s
value.⁴

Loss Deductions

In 2023, the IRS Office of Chief Counsel addressed a situation where a taxpayer attempted to take a Section 165 loss deduction with respect to worthless or abandoned cryptocurrency on their 2022 federal income tax return.⁵ In the end, the IRS noted that the taxpayer would still have not had a deductible loss because miscellaneous itemized deductions subject to the 2% floor are suspended through 2025. However, the IRS also addressed the issues as they would have applied had the deduction not been suspended to offer insight to taxpayers going forward.