IRS Releases Cryptocurrency Guidance on Dealing With 'Hard Fork'

By:
Chris Gaetano
Published Date:
Oct 11, 2019
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The IRS has released its first new cryptocurrency guidance since 2014 on how to account for a situation known as a "hard fork," basically when one cryptocurrency changes its protocol and becomes two. For example, Bitcoin XT forked off of the original bitcoin due to a protocol change that allowed for a larger number of transactions by changing the size of the blocks in the blockchain from one to eight megabytes. Digital currency Ethereum, meanwhile, forked in order to address a security vulnerability and refund victims of a hack. 

The IRS guidance said that when a cryptocurrency forks, sometimes the action is followed by an "airdrop" of new tokens to holders of the previous ones. Sometimes, when there is an airdrop, however, the holder still doesn't initially have control of the asset because of potential software incompatibilities with exchanges. This lead to questions such as whether this counts as income and, if so, when it should be recorded. 

The IRS said that in the event that a cryptocurrency forks, but it is not followed by an airdrop of new tokens, then there is no gross income to consider. 

In the event that the fork is followed by an airdrop, the new tokens are considered income and are recorded at the time of the airdrop, when it is recorded in the distributed ledger. Even if the taxpayer cannot actually use the token due to software incompatibilities, the IRS said the taxpayer still has the ability to dispose of it, and so therefore it counts as income. 

The latest IRS guidance is far more targeted than the first document released in 2014, which laid out an overall framework for how it would treat cryptocurrencies for tax purposes. For those who'd like a refresher on these policies, the IRS also released an FAQ breaking down how taxpayers should treat these assets. 

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