2018 Articles

Schrödinger’s Currency: How Virtual Currencies Complicate the RIC and REIT Qualification Requirements

Pond, Laura Davidson

Bitcoin and other virtual currencies have created new opportunities for individuals to invest in a rapidly appreciating new asset class, but the Internal Revenue Code has been unable to keep pace with this new technology. Because the Code does not suitably define what a virtual currency is in the contexts of Regulated Investment Companies (RICs) or Real Estate Investment Trusts (REITs), the concepts of “good” income and “good” assets in I.R.C. §§ 851 (RICs) and 856 (REITs) are inapplicable to virtual currency. Under the current regime, a RIC or a REIT may not be able to invest directly in virtual currency without compromising the investment entity’s qualification as a tax-favorable pass-through entity.

The legislative purposes behind Sections 851 and 856 suggest that digital currency possesses the characteristics of “good” income and “good” assets. Accordingly, RICs and REITs should be able to invest in this potentially lucrative new technology without risking disqualification as a tax-favored entity because virtual currency could constitute a “security” for the purposes of Sections 851 and 856. Yet the Code’s RIC and REIT rules require that any qualifying security be registered under the Investment Company Act of 1940. Virtual currency is not yet regulated under the 1940 Act, and thus cannot qualify as a security for the purposes of the RIC and REIT “good” income and “good” asset tests.

The inability of the Code and the ’40 Act to adapt to new technology makes virtual currency a nonviable investment for RICs and REITs, but even more so, renders the unyielding nexus between the ‘40 Act and Code Sections 851 and 856 nonsensical. The I.R.C. must somehow provide for the possibility of RIC or REIT investment in a non1940 Act security, while avoiding the significant non-tax consequences attendant with a sweeping classification of all virtual currency as securities. The Investment Company Act of 1940 should supplement—not comprise—the tax rules that define the kinds of income and assets that allow an entity to qualify as a RIC or a REIT.