A “hard fork” of a cryptocurrency owned by a taxpayer does not result in gross income for a taxpayer if the taxpayer receives no units of the new cryptocurrency, but taxpayers receiving an “airdrop” of units of a new cryptocurrency after a hard fork have ordinary gross income from the airdrop, the IRS ruled in Rev. Rul. 2019-24, issued Wednesday. The IRS also updated its Virtual Currency Transactions frequently asked questions on its website to reflect the ruling.
Rev. Rul. 2019-24 supplements basic guidance on the tax treatment of virtual currency that the Service issued in 2014 (Notice 2014-21).Taxpayers and practitioners, the latter including the AICPA, have been pressing for more guidance on the tax treatment of virtual currency and its many new and evolving types of transactions.
Cryptocurrency, the IRS explains, is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. A distributed ledger records, shares, and synchronizes transactions as data on digital systems without any centralized storage or administration. The new revenue ruling addresses a specific type of cryptocurrency transaction known as a hard fork that is often, but not always, followed by an airdrop.
A hard fork is unique to distributed ledger technology and occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may create from one cryptocurrency a new cryptocurrency on a new distributed ledger in addition to the original cryptocurrency on the original distributed ledger.
The IRS explained that receipt of cryptocurrency from an airdrop generally occurs when it is recorded on the new distributed ledger, but receipt for tax purposes may occur later or, constructively, earlier, depending on when the taxpayer is able to exercise dominion and control over the new cryptocurrency. For example, an airdropped cryptocurrency might not be immediately credited to a taxpayer’s account at a cryptocurrency exchange that does not yet support that cryptocurrency. In that case, the taxpayer is treated as receiving the cryptocurrency later, once it is credited to the taxpayer’s account and the taxpayer is able to transfer, sell, exchange, or otherwise dispose of it.
The revenue ruling gives two examples: one of a taxpayer whose cryptocurrency undergoes a hard fork, creating a new cryptocurrency, but units of the new cryptocurrency are not airdropped or otherwise transferred into an account that the taxpayer owns or controls. Because the taxpayer receives no units of the new cryptocurrency, that taxpayer does not at that point have gross income for federal tax purposes.
The second example is similar to the first, except that in addition to the hard fork, units of the new cryptocurrency are airdropped into the taxpayer’s distributed ledger address, and the taxpayer is able to immediately dispose of the new units. In this case, because the taxpayer receives units of the new cryptocurrency, the taxpayer has an accession to wealth and ordinary income in the tax year in which the new cryptocurrency units are received. The amount of the ordinary income is the fair market value of the new units when the airdrop is recorded on the distributed ledger.
— Paul Bonner (Paul.Bonner@aicpa-cima.com) is a JofA senior editor.