IRS Finally Provides Cryptocurrency Tax Guidance
Do you hold or use cryptocurrency? Then you should know that on Oct. 9, 2019, the IRS issued Revenue Ruling 2019-24 and 43 Questions and Answers. What are they? The first updated guidelines since 2014 that dictate how virtual currency transactions can be taxed. So if you had questions, there are some new answers! Ready to learn more?
While the Revenue Ruling focuses on how to treat hard forks and airdrops, the 43 Questions and Answers deal with a variety of common transactions, uses and valuation matters that could help you.
Let's begin with some preliminary definitions.
- A hard fork signifies a distinct change in a cryptocurrency’s protocol that creates a permanent divergence from the previous distributed ledger. Sometimes, a hard fork can result in the creation of a new cryptocurrency, as well as a new distributed ledger.
- If a hard fork does result in the creation of a new cryptocurrency, units of that new cryptocurrency may be distributed to multiple taxpayers automatically using a method called airdrop. While an airdrop will not always occur after a hard fork, if an airdrop does occur, then units of the new cryptocurrency are distributed to taxpayers who owned the legacy cryptocurrency.
The IRS's position.
So what is the IRS's position on whether and when hard forks and airdrops generate taxable income for the taxpayer? The new guidance analyzes hard forks and the generation of income.
Basically, the IRS says that a taxpayer does not have income if they do not receive units of a cryptocurrency, even in the event of a hard fork. However, as soon as an airdrop occurs and the taxpayer receives units of the cryptocurrency, then the taxpayer does have taxable income. So, you win some, you lose some.
For example, consider the first block in the creation of a hard fork, the point at which there is zero value. Can a taxpayer recognize a hard fork as income, before the hard fork creates a new cryptocurrency? Thus, in this scenario, when the hard fork was created, it had a value of zero, resulting in zero income. In this case, the holding period would have started and no income would be recognized until the digital asset from the hard fork is sold. This scenario is comparable to the result of making an 83(b) election on shares purchased or received that are not vested.
As with most Revenue Rulings issued by the IRS, Revenue Ruling 2019-24 seems to leave taxpayers with more questions than answers. (womp womp) The Q&A-style publication is a separate resource aiming to clarify how other common virtual currency transactions should be accounted for, primarily tackling the most challenging topics surrounding virtual currency and taxability.
Significant topics covered in the 43 Questions and Answers:
In Question 27, the IRS addresses the valuation of services provided in exchange for the receipt of a cryptocurrency, whereby the cryptocurrency cannot be valued. The IRS indicates that the “fair value of the cryptocurrency received is equal to the fair market value of the property or services exchanged for the cryptocurrency when the transaction occurs.” As compared to transactions that occur when shares of a private company are transferred when services are provided, the IRS has ruled that the shares must be valued.
Question 29 provides clear guidance on soft forks, and specifically states that since “soft forks do not result in you receiving new cryptocurrency, you will be in the same position you were in prior to the soft fork, meaning that the soft fork will not result in any income to you.”
Question 38 provides clarity on how to identify the cost basis and units sold of virtual currency. The positive or negative implication of this guidance depends on a taxpayer’s trading volume and/or the positions the taxpayer took in the past. The IRS states that “if you do not identify specific units of virtual currency, the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order beginning with the earliest unit of the virtual currency you purchased or acquired; that is, on a first in, first out (FIFO) basis.” Within the Q&A the IRS recognizes that every purchase and sale of a digital asset that happens on-chain can be specifically identified, and they are expecting taxpayers to track their transactions as such.
It is important to note that, while the IRS can publish Revenue Rulings and release Questions and Answers, these positions are not actual tax law; however, if audited, a taxpayer will need to defend why a position contrary to these published guidelines is proper. So, be ready and good luck. =)