IRS has issued guidance on how to treat the cryptocurrency hard fork and airdrops for tax purposes.
IRS Ruling 2019-24 specifically addresses cryptocurrency hard fork and airdrops tax treatment.
The guidance provides that the taxpayers do not have to recognize the hard forks as income if they are not able to “claim the dominion” over the token or coin.
IRS provides an example, “a taxpayer does not have dominion and control if the address to which the cryptocurrency is airdropped is contained in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange does not support the newly-created cryptocurrency such that the airdropped cryptocurrency is not immediately credited to the taxpayer’s account at the cryptocurrency exchange.”
Hard fork does not generate income automatically
The rules are summarized in these two situations: “(1) A taxpayer does not have gross income under § 61 as a result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency.
(2) A taxpayer has gross income, ordinary in character, under §61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency.”
Just because you hold a cryptocurrency that undergoes hard fork does not automatically trigger a tax event for you if you have not received the possession of the cryptocurrency.
However, if you take possession of hard fork token or you are a recipient of an cryptocurrency airdrop then you have received income, at fair market value, that needs to be reported on the tax returns.
You owe tax even if you don’t sell your hard fork tokens
Whether you decide to hold or sell your hard fork tokens – you will owe taxes as of the date of receipt.
For the purposes of determining receipt, IRS provided an example in the ruling which elaborates that whenever the individual receives the hard fork or airdrops and has the ‘ability’ to take possession and transact, then the income is recognized. This is true even if the taxpayer chooses not to take possession of the said token/coin.
Taxpayers have to plan ahead
In most cases, we have seen that the tokens distributed during a hard fork get hyped and are priced at a very high price at the beginning, however, once the hype settles down, the price may fall drastically.
We have seen this with Bitcoin Cash, Bitcoin SV and many more.
Per the guidance provided by the IRS, taxpayer has to recognize income on the day of receipt, at fair market value. That FMV could be a lot more than what that token is valued later.
Depending on your expectations and preference – you have to prepare for the impending taxes.
For instance, let’s say on the day of hard fork of a token (assuming you have received the possession on the same day) the price is $100 per token and you received 1000 of these tokens. You held on to these tokens and by the end of the tax year the value is $10.
You are now required to report $100 * 1,000 = $100,000 as your income on your tax returns while the value of these tokens at the end of the year was 1/10th, that is, $10,000.
When you report the $100,000 income, your cost basis in the token becomes $100 per token. Let’s say you eventually end up selling these tokens at a later year at $10 per token. Now you are able to show that you have a net capital loss of $90,000 ($10,000 less $100,000).
But here is the issue, you are only allowed to take a loss of up to $3000 each year in the US. That means, it would be a long time before you can claim the losses completely.
Due to these complications, it is important for individuals to plan ahead, consult a tax professional and take necessary steps to avoid sticker shock later.
Thank you for reading the article.
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RK Reddy holds two Masters degrees, one in Accounting and another in Business Administration with over 15 years of experience in the financial services industry.
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