US stocks and Bitcoin plunge together, IRS reiterates capital gains tax on "coin-to-coin" transactions

Due to the possibility of interest rate hikes coming earlier than expected, both the U.S. stock market and Bitcoin plunged last night on 6/18. The Dow Jones Index dropped over 500 points, while Bitcoin briefly fell below $35,000. The U.S. IRS reiterated that cryptocurrency transactions are not eligible for like-kind exchange treatment, which also seems to have impacted the market.

The Fed's Rate Hike Threat Intensifies

St. Louis Federal Reserve Bank President James Bullard revealed in an interview with CNBC that he expects the first rate hike to come in 2022.

He believes that by the end of 2022, the inflation rate will be around 2.5% to 3%, which aligns with the Fed's new framework for setting rates, allowing rates to run above target for some time before falling to 2%. He also pointed out that leaning towards a more hawkish stance to curb inflation pressures is nothing out of the ordinary.

Bullard is not a voting member of the Federal Open Market Committee (FOMC) this year, but will have a vote in 2022.

U.S. Stocks and Bitcoin Tumble

Previously, the Fed had indicated that it would not raise rates until at least 2024, and Chairman Jerome Powell had stated that the probability of a rate hike by the end of 2022 was low. However, on June 16, the FOMC unanimously agreed to keep rates near zero, but the earliest rate hike could come in 2023.

The U.S. stock market had already reacted with a decline to this news, but Bullard's interview on June 18 caused even more pronounced market volatility.

The Dow Jones Industrial Average fell over 500 points, or 1.62%, and Bitcoin briefly dropped below $35,000, hitting a low of $34,833, with a 7% drop in 24 hours.

The latest guidance from the Internal Revenue Service (IRS) also seemed to impact the market.

Like-Kind Exchanges Not Applicable to Cryptocurrency Trading

Like-Kind Exchanges, also known as the 1031 exchange, apply to real estate investments and business use within the U.S. If an individual's real estate transactions are solely for "investment conversion," selling an existing property to purchase a higher-priced or commercial property, they do not have to pay capital gains tax until they sell the property for fiat currency.

This has led to a surge in property prices, but when President Biden proposed a wealth tax in April this year, he planned to abolish the 1031 exchange.

Prior to 2018, due to unclear cryptocurrency regulations, some investors used the 1031 exchange to avoid capital gains tax. However, the IRS's latest memorandum reaffirmed:

Trading between Bitcoin, Ethereum, and Litecoin does not qualify under the Like-Kind Exchanges.

This memorandum released on June 18 states that before January 1, 2018, Bitcoin, Litecoin, and Ethereum did not qualify for Like-Kind Exchanges.

The document points out that exchanges may have up to 30 different cryptocurrencies, but almost all tokens can be traded with Bitcoin, Ethereum, and fiat currencies, and these tokens differ in design, intended use, actual use, nature, and characteristics.

Therefore, trades like "BTC/LTC," "ETH/LTC," "BTC/ETH," etc., do not qualify under the 1031 Like-Kind Exchanges. This also means that similar transactions executed by U.S. citizens before 2018 may be deemed taxable events.

This memorandum was issued by the Office of the IRS Chief Counsel, who is appointed by the U.S. President and confirmed by the Senate. Their responsibilities include interpreting, managing, and enforcing domestic tax laws, as well as all other legal matters.