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In an attempt to clarify reporting obligations, the IRS has provided new guidance which supplements the IRS issued guidance on virtual currency in Notice 2014-21.
The new guidance includes Revenue Ruling 2019-24. The guidance addresses two main points. Does a taxpayer have gross income under subsection 61 of the Internal Revenue Code as a result of hard fork of cryptocurrency owned by the taxpayer if the taxpayer does not receive units of a new cryptocurrency? Does a taxpayer have gross income under subsection 61 as a result of an airdrop of new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency? The answer is, it depends.
A hard fork takes place when cryptocurrency on a distributed ledger has a protocol change causing a permanent diversion from the existing distributed ledger. Often, hard forks result in a new distributed ledger and the creation of a new cryptocurrency. An airdrop is a distribution of units of cryptocurrency to ledger addresses of multiple taxpayers.
So, what does this all mean? Essentially, if there is a change in protocol to your current cryptocurrency, a new cryptocurrency and ledger is created with the new protocol. Any transactions with the original cryptocurrency will be maintained on the original ledger. If new cryptocurrency is issued as a result of the hard fork and airdrop, the new cryptocurrency is maintained on a separate ledger. The value of the cryptocurrency on the original ledger and the value of the new cryptocurrency on the new ledger will be different, and for tax purposes transactions for each ledger need to be maintained separately.
Moreover, the taxpayer's receipt date of the cryptocurrency depends on whether or not the taxpayer is able to exercise dominion and control over the cryptocurrency. The taxpayer does not have dominion and control when cryptocurrency is airdropped and contained in a wallet managed through an exchange and the exchange does not support the newly-created cryptocurrency.
A taxpayer is taxed on a hard fork followed by an airdrop where the taxpayer receives a new cryptocurrency. Alternatively, if there is a hard fork, but the taxpayer does not receive a new cryptocurrency, then the taxpayer does not have a taxable event.
Cryptocurrency is a complicated tax matter and misreporting cryptocurrency transactions may result in late fees, penalties and even criminal prosecution. When investing in cryptocurrency, it is highly recommended you meet with your tax advisor to gain an understanding of how to report correctly.