IRS Rules Bitcoin-Ethereum Swaps Cannot Qualify as Tax-Free Like-Kind Exchanges

The United States Internal Revenue Service issued a landmark legal memorandum on June 18, 2021, definitively ruling that swaps between Bitcoin, Ethereum, and Litecoin do not qualify for tax-deferred like-kind exchange treatment under Section 1031 of the Internal Revenue Code — even for transactions completed before the 2017 Tax Cuts and Jobs Act limited such treatment to real property.

TL;DR

• IRS Legal Memorandum 202124008, issued June 18, 2021, denies like-kind exchange treatment for crypto-to-crypto swaps
• Exchanges of BTC for ETH, BTC for LTC, and ETH for LTC are all taxable events under the ruling
• The guidance applies retroactively to pre-2018 transactions, potentially creating tax liability for early crypto traders
• IRS reasoned that the three cryptocurrencies differ fundamentally in nature and character
• Tax professionals had long considered using Section 1031 for crypto swaps an extremely risky position

The IRS Ruling Explained

In ILM 202124008, the IRS examined whether taxpayers could defer capital gains when exchanging one cryptocurrency for another by claiming the transactions qualified as like-kind exchanges under Section 1031. The answer was an unequivocal no. The IRS concluded that swapping Bitcoin for Ether, Bitcoin for Litecoin, or Ether for Litecoin does not qualify as a like-kind exchange because the cryptocurrencies involved differ fundamentally in their nature and character.

The ruling carries particular weight because it applies to transactions that occurred before January 1, 2018 — the date when the Tax Cuts and Jobs Act (TCJA) restricted Section 1031 treatment exclusively to real property. This means that crypto traders who had previously relied on Section 1031 to defer gains on pre-2018 token swaps may now face retroactive tax liability on those transactions.

How the IRS Distinguished Bitcoin, Ethereum, and Litecoin

The IRS’s analysis hinged on determining whether each cryptocurrency pair could be considered “like-kind” based on the nature or character of the properties involved, rather than their grade or quality. The agency drew on decades of precedent involving exchanges of currencies and precious metals.

Regarding Bitcoin and Litecoin, the IRS noted that Bitcoin and Ether play a fundamentally different role in cryptocurrency markets compared to Litecoin. Most cryptocurrency trading pairs are denominated in either Bitcoin or Ether, meaning that investors wanting to trade in other cryptocurrencies must typically exchange those currencies into or from Bitcoin or Ether. This special intermediary role made Bitcoin and Ether different in nature and character from Litecoin.

As for Bitcoin versus Ethereum, the IRS acknowledged that while both serve as trading base pairs, their underlying technologies make them fundamentally different. The Bitcoin network is designed to function as a payment network with Bitcoin serving as the unit of payment. In contrast, the Ethereum blockchain functions both as a payment network and as a platform for executing smart contracts and decentralized applications, with Ether serving as the fuel for those capabilities. This distinction in technological purpose was sufficient, in the IRS’s view, to render them not like-kind.

Historical Precedent

The IRS anchored its reasoning in established revenue rulings on currency and precious metals. In Revenue Ruling 79-143, the IRS previously held that numismatic-type coins — those deriving value from age, scarcity, history, and aesthetics — are not like-kind to bullion-type coins that derive value from metal content. In Revenue Ruling 82-166, the IRS ruled that gold bullion is not like-kind to silver bullion because silver’s value is derived largely from industrial uses while gold’s value comes primarily from investment and speculation.

These decades-old precedents demonstrated the IRS’s long-standing skepticism toward like-kind exchanges between different types of currency and value stores, even when both are held for investment purposes. The agency applied the same analytical framework to cryptocurrencies with the same result.

Implications for Crypto Taxpayers

The ruling effectively closed a loophole that some early cryptocurrency adopters had hoped would shield them from significant tax obligations. Tax professionals at firms like RSM had been cautioning clients for years that relying on Section 1031 for cryptocurrency exchanges was an extremely risky tax position. The June 18 memorandum confirmed those warnings.

For taxpayers who had reported pre-2018 crypto-to-crypto swaps as like-kind exchanges, the ruling potentially opened the door to additional tax assessments, penalties, and interest. The guidance also reinforced that all cryptocurrency exchanges beginning in 2018 and beyond are definitively subject to income tax, as the TCJA had already eliminated Section 1031 treatment for all personal property.

Why This Matters

The IRS’s June 18, 2021, ruling on cryptocurrency like-kind exchanges was a defining moment in the maturation of crypto tax policy in the United States. By establishing clear precedent that different cryptocurrencies are not like-kind to one another, the IRS removed one of the last significant areas of tax ambiguity for digital asset traders. The decision underscored a broader trend: as cryptocurrency moved from the fringes to the mainstream of financial markets, regulators were catching up, and the era of informal or uncertain tax treatment was ending. For the growing ecosystem of crypto investors and traders, the message was unmistakable — every swap, trade, and conversion is a taxable event, and accurate record-keeping is not optional but essential.

Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or financial advice. Consult a qualified tax professional for guidance specific to your situation. Cryptocurrency transactions may have significant tax implications.