Author: Leon Clinton

Here’s something to know about cryptocurrencies.

Because cryptocurrencies are classified as “property” rather than as securities, the wash-sale rule does not apply if you sell a cryptocurrency holding for a loss and acquire the same cryptocurrency before or after the loss sale. 

You just have a garden-variety short-term or long-term capital loss depending on your holding period. No wash-sale rule worries. 

This favorable federal income tax treatment is consistent with the long-standing treatment of foreign currency losses.

That’s a good thing, because folks who actively trade cryptocurrencies know that prices are volatile. And this volatility gives you two opportunities:

1. profits on the upswings
2. loss harvesting on the downswings

Let’s take a look at the harvesting of losses:

• On day 1, Lucky pays $50,000 for a cryptocurrency.
• On day 50, Lucky sells the cryptocurrency for $35,000. He captures and deducts the $15,000 loss ($50,000 – $35,000) on his tax return.
• On day 52, Lucky buys the same cryptocurrency for $35,000. His tax basis is $35,000.
• On day 100, Lucky sells the cryptocurrency for $15,000. He captures and deducts the $20,000 loss ($35,000 – $15,000) on his tax return.
• On day 103, Lucky buys the same cryptocurrency for $15,000.
• On day 365, the cryptocurrency is trading at $55,000. Lucky is happy.

Observations:

• Assuming Lucky had $35,000 in capital gains, Lucky deducted his $35,000 in cryptocurrency capital losses. If he had no capital gains, he had a $3,000 deductible loss and carried the other $32,000 forward to next year.
• On day 365, Lucky has his cryptocurrency, which was his plan on day 1. He thought it would go up in value. It did, from its original $50,000 to $55,000.
• Lucky’s tax basis in the cryptocurrency on day 365 is $15,000. 

Here’s what Lucky did:

1. He kept his cryptocurrency.
2. He banked $35,000 in losses.

Be alert. Losses from crypto-related securities, such as Coinbase, can fall under the wash-sale rule because the rule applies to losses from assets classified as securities for federal income tax purposes. For now, cryptocurrencies themselves are not classified as securities.

Planning point. If you want to harvest losses, make sure you hold a cryptocurrency and not a security.

If you would like to discuss cryptocurrencies, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 5, 2021

Let me tell you about Lisa and Jimmy.

They had a very unsatisfactory visit with the IRS. The auditor examined their three rental properties, disallowed their losses, and told them to expect a tax bill for $55,000.

Current score: IRS $55,000 ahead.

But one good thing happened during the visit. The IRS agreed that Lisa was a real estate professional.

The bad thing was that the IRS said that Lisa did not materially participate in the rentals, because the more than 750 hours shown in her logbook included what’s called investor time.

With this, the IRS examiner said that although Lisa is a real estate professional, she failed to materially participate in the properties because she had fewer than 500 hours of material participation.

Properties

Lisa and Jimmy’s rental properties include 

• a condo rented on a month-to-month lease, 
• a single-family home rented on a month-to-month lease, and 
• a vacation cabin rented on a one-week basis for 20 weeks a year. 

They have no personal use of the rentals.

Here’s how we helped Lisa and Jimmy. We started by explaining that the 500 hours are not relevant. That 500-hour rule is just one of seven possible material participation tests that you find in IRS Reg. Section 1.469-5T(a)(1).

Condo. To show the IRS that Lisa and Jimmy materially participated in the condo, we used the “more than 100 hours” test. This test requires that Lisa’s and Jimmy’s participation be more than 100 hours and not less than participation by any other individual.

We used the Pohoski case as our position. In this court case, the taxpayer had to count only the time that front-desk personnel actually spent on his unit, not the total time that they manned the desk. The IRS accepted that Lisa and Jimmy met that test.

Single-family home. Since Lisa and Jimmy did everything in connection with this rental, the IRS had no choice but to allow material participation under the “substantially all” test (one of the seven tests).

Vacation cabin. Lisa did all the work for the vacation cabin, except for that done by a housekeeper who spent three to four hours for each of the 20 weeks that the vacation cabin was rented (say 3.5 x 20 weeks, for a total of about 70 hours of housekeeping). We won material participation here because Lisa’s and Jimmy’s combined efforts were more than 100 hours and more than the housekeeper’s 70 hours.

The combination of our work and Lisa’s and Jimmy’s good tax records enabled Lisa and Jimmy to obtain a “no change” letter—meaning that the $55,000 IRS claim was gone.

If you would like my help on your rental properties, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 4, 2021

If you are suffering or about to suffer an IRS audit, you should know how your tax positions stack up against the IRS examiners’ positions. 

In most cases, you are discussing the facts, not the law, and you prove your facts with receipts, canceled checks, and logbooks. 

Once you get into the law, the rules of engagement work pretty much as I describe below.

Here are three general rules on the persuasiveness of tax documents: 

• Statutes and regulations are highly persuasive with both the courts and the IRS. 
• The next-best authority with the courts is prior case law.
• The next-best authorities with the IRS are IRS documents. But as you’ll see, IRS documents range from very strong to very weak.

Your tax dispute always begins with the IRS. 

At the earliest stages of the audit, you work with auditors and agents whose knowledge of the law comes primarily (or solely) from IRS documents, not statutes or court cases. As you advance your case within the IRS, you deal with supervisors and officers who are more knowledgeable and pay more attention to the code, regulations, and (to a lesser extent) court cases.

Throughout the audit, one thing remains constant: IRS documents remain hugely important at all levels within the IRS. 

After the tax code and regulations, the first type of official IRS publication is a revenue ruling.The revenue ruling reads like a condensed court case and describes how the IRS applies the law to a particular set of facts.

The second type of official publication is the revenue procedure.The IRS uses the revenue procedure to administer the law by updating dollar amounts for inflation and by explaining procedures for making elections or filing forms.

The third type of official publication is the acquiescence or non-acquiescence. At its discretion, the IRS can issue a statement indicating its agreement (acquiescence) or disagreement (non-acquiescence) with a Tax Court ruling.

Last, you’ll find notices and announcements that describe the IRS’s official position on recent issues. You’ll also find private letter rulings and technical advice memoranda that carry weight with the IRS.

The IRS also publishes IRS forms, instructions, publications, and FAQs (guides). The guides are less technical than official pronouncements, and they don’t include citations. The IRS writes the guides in clear terms so that non-professionals can easily understand them. 

Most tax disputes begin and end with the IRS. So where do court cases fit into your legal research?

Court cases matter at the IRS level for two reasons:

• At the highest level of IRS review (appeals), IRS officers consider court cases.
• Court cases usually describe all the statutes, regulations, and other important IRS documents you need in order to support your case. Plagiarizing court cases is not only within the rules for engagement with the IRS but also a great strategy!

Once your tax dispute leaves the IRS and enters court, your best sources of tax authority are statutes, regulations, and prior court cases.

If you have any questions on any of the above, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 30, 2021