The IRS Definition of a Security and a Commodity (Cryptocurrency Analysis Included)

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Discussion
In creating the mark-to-market election for dealers in securities and/or commodities, the IRS provided a definition of what constitutes a security as well as what constitutes a commodity.

Security
The definition of a security is found under IRC 475(c)(2) as:

1. Share of stock in a corporation;
2. Partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust;
3. Note, bond, debenture, or other evidence of indebtedness;
4. Interest rate, currency, or equity notional principal contract;
5. Evidence of an interest in, or a derivative financial instrument in, any security described above, or any currency, including any option, forward contract, short position, and any similar financial instrument in such a security or currency; and
6. A position which is not a security described above, is a hedge with respect to such security, and is clearly identified in the dealer's records as falling under the definition described before the close of the day on which it was acquired.

Note, however, that the IRS specifically states that virtual currency (cryptocurrency) is treated as property (Q-1) and is not treated as currency for purposes of determining whether a transaction results in a foreign currency gain or loss (Q-2) in Rev. Rul. 2014-21.

Commodity
The definition of a security is found under IRC 475(e)(2) as:

1. Any commodity which is actively traded (Section 1092(d)(1));
2. Any notional principal contract with respect to any commodity described above;
3. Any evidence of an interest in, or a derivative instrument in, any commodity described above, including any option, forward contract, futures contract, short position, and any similar instrument in such a commodity and;
4. Any position which is not a commodity described above, is a hedge with respect to such a commodity, and is clearly identified in the taxpayer's records under the definition described before the close of the day on which it was acquired.

Section 1092(d)(1) describes a commodity as:

1. Any personal property of a type which is actively traded.

Actively traded personal property is best defined under Reg. 1.1092(d)-1 as traded on an established financial market. An established financial market is defined as:

1. A national securities exchange that is registered under section 6 of the Securities Exchange Act of 1934;
2. An interdealer quotation system sponsored by a national securities association registered under section 15A of the Securities Exchange Act of 1934;
3. A domestic board of trade designated as a contract market by the Commodities Futures Trading Commission;
4. A foreign securities exchange or board of trade that satisfies analogous regulatory requirements under the law of the jurisdiction in which it is organized (such as the London International Financial Futures Exchange, the Marche a Terme International de France, the International Stock Exchange of the United Kingdom and the Republic of Ireland, Limited, the Frankfurt Stock Exchange, and the Tokyo Stock Exchange);
5. An interbank market;
6. An interdealer market; and
7. Solely with respect to a debt instrument, a debt market.

An interdealer market is characterized by a system of general circulation that provides a reasonable basis to determine fair market value by disseminating either recent price quotations of one or more identified brokers, dealers, or traders or actual prices of recent transactions. An interdealer market does not include a directory or listing of brokers, dealers, or traders for specific contracts that provides neither price quotations nor actual prices of recent transactions.

Although many of the court cases surrounding commodities describe personal property as tangible, property tax law describes personal property as being either tangible or intangible. In considering the application of the above law to cryptocurrency, the CFTC previously ruled in 2015 that cryptocurrency is a type of commodity. The definitions described above do not preclude the IRS from following the treatment established by the CFTC.

References
https://www.law.cornell.edu/uscode/text/26/475
https://www.law.cornell.edu/cfr/text/26/1.475(c)-2
https://www.law.cornell.edu/uscode/text/26/1092
https://www.irs.gov/pub/irs-drop/n-14-21.pdf
http://www.cftc.gov/PressRoom/PressReleases/pr7231-15

Disclosure
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.