Can You Do a 1031 Exchange on Cryptocurrency?

The Internal Revenue Code has traditionally permitted investors to exchange real property used for business or held for investment purposes for other business or investment property of the same type and has referred to these swaps as “like-kind exchanges.” Thus, making such an exchange would not expose the taxpayer to taxes on any gain unless they received the increase as non-like property or in money.

The exchange has strict rules associated with the transaction, primarily designed to ensure that the taxpayer does not have control over the proceeds from the sale of the relinquished asset before the replacement property is acquired. In addition, the code requires that the investor follow specific timelines to maintain eligibility for the deferral of the tax.

The Tax Cuts and Jobs Act of 2017 restricted IRC Section 1031 to exchanges of real property. The statute specifically excluded all personal and intangible property, such as machinery, equipment, vehicles, artwork, collectibles, patents, and intellectual properties. A transition provision in the Act allowed exchanges for those excluded examples if the taxpayer disposed of the property (or received replacements) before December 31, 2017.

As a result, any item outside of real estate held for investment or used for business is not eligible for a 1031 exchange transaction. Stocks do not qualify (and never did), but virtually any real estate held for business use does. Real estate held primarily for sale does not—in other words, if a developer is building to sell, or a real estate "flipper" is buying a house to remodel and sell, they cannot trade those assets for other properties in a 1031 exchange.

However, the "like-kind" allowances are typically lenient, with multi-family housing being exchangeable for commercial office space or retail swapped for farmland. The investor can even exchange real property for a fractional interest in a DST via a 1031 exchange.

Did Cryptocurrency Swaps Ever Qualify?

Some excluded trades include the following:

•       Stocks and securities
•       Certificates of trust
•       Partnership interests
•       Goodwill
•       Foreign property for US property (although an investor can exchange one property in a foreign country for a different property in the same or another foreign country)

Based on guidance issued by the IRS in a Chief Counsel Advisory, cryptocurrency swaps did not qualify for 1031 exchanges even before the restrictions put into place by the TCJA. According to the IRS, cryptocurrency, or virtual currency, is a digital representation of value and treats it as property rather than money. In IRS Notice 2014-21; Rev. Rul. 2019-24, they discussed the distinct characters of various cryptocurrencies and their respective functionalities to conclude that they played fundamentally different roles in the marketplace and did not allow a like-kind exchange.

Interestingly, while the IRS seems open-handed in its treatment of business property in applying the definition of like-kind swaps, it used a more restrictive standard in other cases, such as the digital currency. Similarly, before the TCJA, an investor attempting to swap gold coins for silver or even one type of gold coin for a different kind may have found the exchange ruled ineligible by the IRS (Rev. Rul. 79-143) based on disparity in "like-kind" similarity.