Nearly five years after its first and only published guidance on the tax treatment of cryptocurrency, on October 9, 2019, the IRS issued Revenue Ruling 2019-24 (addressing the tax consequences of “forks”) and an expanded FAQ(which applies the principles outlined in Notice 2014-21 to a larger number of situations). The additional guidance provides welcome clarity to a number of outstanding questions, including:
Tax consequences of “forks”
A hard fork is when a single cryptocurrency splits in two, normally due to the distributed ledger undergoing a protocol change. The IRS has ruled that a hard fork resulting in a new “coin” being “airdropped” to a taxpayer’s wallet is taxed as ordinary income equal to the fair market value of the new cryptocurrency received. If a person does not receive new coins after a hard fork, there is no taxable income. This rule could be problematic, as there are many instances where cryptocurrency owners can have taxable income without knowing it. A soft fork is when the protocol change does not result in a split and does not result in the creation of a new cryptocurrency; because no new cryptocurrency is received as a result of a soft fork, soft forks should not be taxable.
Cost basis of cryptocurrency
Where a taxpayer purchases cryptocurrency, the IRS clarified that the cost basis of cryptocurrency includes all the money spent to acquire the cryptocurrency, “including fees, commissions and other acquisition costs in US dollars.” When cryptocurrency is received in exchange for services, though, the basis of the cryptocurrency is “fair market value of the virtual currency, in US dollars, when the virtual currency is received.” The IRS has also clarified how to determine the fair market value of cryptocurrency. Cryptocurrency traded on an exchange should be valued at the US dollar price on that specific exchange, not the price referenced on a third party website. Cryptocurrency not traded on an exchange (for example, peer-to-peer exchanges) should be valued by reference to “a blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculated the value of cryptocurrency. If you do not use an explorer value, you must establish that the value you used is an accurate representation of the cryptocurrency's fair market value.” For cryptocurrency for which there is no published value, which is not uncommon, the fair market value of the cryptocurrency received is equal to the fair market value of property or services exchanged.
As with shares of stock, persons buying different units of the same cryptocurrency over time are likely to have a different cost basis and holding period in those units. The IRS confirmed that holders of cryptocurrency may use specific identification for trading units of cryptocurrency, rather than the default rule of “first-in-first-out” (FIFO), which means that taxpayers can pick and choose which unit of cryptocurrency they are disposing of, which is often helpful for managing taxes. In order to use specific identification, however, a taxpayer must be able to identify (i) the date and time each unit was acquired, (ii) the basis and the fair market value of each unit at the time it was acquired, (iii) the date and time each unit was sold, exchanged or otherwise disposed of, and (iv) the fair market value of each unit when sold, exchanged or disposed of, and the amount of money or the value of property received for each unit. Without this information, a taxpayer will be required to use the default FIFO rule. In short, holders of cryptocurrency should make all efforts to maintain records sufficient for establishing positions to be taken on tax returns.
Transfers between wallets
The IRS has confirmed that transferring cryptocurrency from one wallet to another wallet (or exchange accounts) is a nontaxable transfer, which comes as welcome relief to taxpayers that recently received notices from the IRS.