IRS updates cryptocurrency rules
The Internal Revenue Service on Wednesday issued its first official ruling, and its first guidance of any kind since 2014, on cryptocurrency taxes.
The revenue ruling answers common questions regarding the tax treatment of cryptocurrency “hard forks” and “airdrops,” a process by which new currencies essentially are split off from old ones. An example is when holders of bitcoin received bitcoin cash, a spinoff of the bestknown cryptocurrency.
A revenue ruling is an official IRS interpretation that can be relied upon by all taxpayers. In 2014, the IRS issued guidance that explained its thinking on more fundamental issues involving cryptocurrencies. However, guidance doesn’t
carry the same weight as a revenue ruling.
Along with its revenue ruling, the IRS issued a list of answers to questions that grew out of its previous guidance.
The 2014 guidance said, “For federal tax purposes, virtual currency is treated as property.” It said that a taxpayer who receives virtual currency as payment for goods or services must include it in income. And if held for investment, it should be treated like any other capital asset, such as stocks or real estate.
Over the past few years, the IRS has been cracking down on people who were not reporting their cryptocurrency transactions. In July, it started sending letters to more than 10,000 taxpayers with virtual currency transactions who potentially failed to report income and pay the proper tax.
The revenue ruling answered two questions not addressed in its earlier guidance: Does a taxpayer have income as a result of a hard fork of a cryptocurrency if the taxpayer does not receive units of a new cryptocurrency? And does a taxpayer have income as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency?
The IRS said a hard fork 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 result in the creation of a new cryptocurrency” in addition to the old currency. The ledger, such as blockchain, is where transactions using digital currency are recorded.
An airdrop, it continued, “is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers.” In other words, “the airdrop is a giveaway of digital currency to people that have accounts that qualify” for the distribution, said Paul Beecy, a partner with Grant Thornton in Boston.
The IRS said a “hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency.” However, “a hard fork is not always followed by an airdrop.”
The IRS concluded that taxpayers do not have income as a result of a hard fork if they do not receive units of a new cryptocurrency. They do have ordinary income if they receive units of a new cryptocurrency in an airdrop following a hard fork.
Translation: “If you have a digital currency and the digital currency has simply changed the ledger it is recorded on and your wealth position hasn’t changed, then you have no income event,” Beecy said. If the airdrop results in an “accession to wealth,” it is taxable.
Erik Weinapple, a tax senior manager with San
“If you have a digital currency and the digital currency has simply changed the ledger it is recorded on and your wealth position hasn’t changed, then you have no income event.” Paul Beecy, a partner with Grant Thornton in Boston on new IRS ruling
Francisco accounting firm Moss Adams, explained that “just because a fork happened doesn’t necessarily mean you have a taxable event.” If you receive a new coin in your digital wallet, but the exchange holding your wallet decides not to participate in the new coin, “then you might not have constructive receipt and therefore may not have a taxable event under the new ruling,” he said.
Beecy said the new ruling “continues with the consistent theme of treating digital currency as property.” So do the numerous answers released Wednesday.
One says that if you donate virtual currency to a charitable organization, you will not recognize income, gain, or loss from the donation. Your charitable contribution deduction “is generally equal to the fair market value of the virtual currency at the time of the donation if you have held the virtual currency for more than one year.” If you held the currency for one year or less, “your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution.”
It also said that if investors sell units of virtual currency obtained at different times, “you can specifically identify which unit or units of virtual currency are involved in the transaction,” the same option you generally have when selling stocks or other securities.
If you do not identify specific currency units, the units deemed to have been sold will be in chronological order, starting with the earliest acquired. This is also known as the firstin, firstout, or FIFO, basis.
The IRS also clarified that if you transfer virtual currency from a wallet, address or account belonging to you to another belonging to you, it is not a taxable event, the same way moving “cash from one bank to another is not taxable,” Weinapple said.