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COLUMNS Tax Planning

Hard Forks and Airdrops: IRS Issues New Guidance on Taxation

by Ryan Firth, CPA, CCFC

Ryan Firth, CPA, CCFC, is while another group of network partici- one BCH coin for one BTC coin. At the the founder and president pants follows the old protocol, or one that time of the , one BTC was worth of Mercer Street Personal is substantially different from the new approximately $2,800 and one BCH was Financial Services, protocol. In other words, the two protocols worth approximately $340.2 Applying the an independent RIA are incompatible with each other, and guidance in Rev. Rul. 2019-24, a taxpayer firm based in Houston, thus by extension, so are the networks. (A who held one BTC at the time of the hard Texas, that serves small hard fork is also commonly referred to as fork would recognize $340 of ordinary business owners, young a “chain split” because there are now two income, but only if the taxpayer was able professionals, entrepreneurs, and growing families in post the fork event.) to “exercise dominion and control” over the wealth-building phase of their lives. Typically, crypto holders who held the BCH. A taxpayer has dominion and coins or tokens prior to the hard fork control over the if he has After a five-year hiatus, the IRS retain those same coins in the same crypto the ability to “transfer, sell, exchange, or issued Revenue Ruling 2019-24 and wallet and can claim the new coins in a otherwise dispose of the cryptocurrency.” frequently asked questions (FAQ) on new wallet from the new crypto network If any one of these criteria is met, then virtual currency transactions on Oct. 9, equal to the number of coins they held at the taxpayer has constructively received 2019.1 Prior to Rev. Rul. 2019-24, the only the moment of the chain split. In some the cryptocurrency, and his tax basis would formal guidance taxpayers had on the respects, hard forks are analogous to a be established based on the fair market tax treatment of these transactions was corporate spin-off; though not for tax value of the crypto at that time. If the IRS Notice 2014-21, which declared that reporting purposes, of course. taxpayer cannot exercise dominion and virtual currency—also called cryptocur- Airdrops are typically crypto tokens control over the newly created cryptocur- rency, or crypto, for short—is to be treated or coins that are distributed gratis to rency (which commonly happens when as property for federal tax purposes. individuals who participate in a com- virtual currency is held at a cryptocurrency One item not specifically addressed munity. For example, the individual might exchange), then the taxpayer does not in Notice 2014-21 was how taxpayers be a crypto newsletter subscriber or a recognize gross income until he construc- should report virtual currency they user of a messaging application. Airdrops tively receives the cryptocurrency. received from a hard fork or airdrop are primarily used for marketing and Once the taxpayer is able to exercise (defined below). Specifically, Rev. Rul. promotional purposes to raise awareness dominion and control (typically when 2019-24 states that virtual currency of a cryptocurrency. Contrary to what is the credits received from a hard fork or airdrop is written in Rev. Rul. 2019-24, airdrops and the taxpayer’s account with the new to be reported by the taxpayer as gross hard forks are mutually exclusive events, cryptocurrency) then the taxpayer must income, which will generally be treated usually. Semantics aside, the tax result recognize income on the date the crypto as ordinary income, and thus subject to is the same whether a taxpayer receives was constructively received based on the the taxpayer’s highest marginal tax rate. virtual currency via an airdrop or a hard fair market value of the crypto at that fork: it’s all treated as gross income. time. Using the BCH example again, if What’s a Hard Fork and an Airdrop? the taxpayer custodied his one BTC coin A hard fork occurs when a cryptocur- A Recent Example at a crypto exchange that did not credit rency’s network protocol (the rules that Perhaps the most prominent hard fork his account until Dec. 20, 2017, then he describe how the network should operate) to date was Cash (BCH), which would recognize approximately $4,355 of changes such that one group of network was spun off from Bitcoin (BTC) in income, which was the price of BCH on participants adopts the new protocol, August 2017. Bitcoin holders received that date.3 That’s a nearly $4,000 differ-

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ence from the date of the hard fork. As a cryptocurrency with unrealized losses to point of reference, in early December of purchase personal-use property such as a LEARN MORE 2019, BCH was trading at around $215. home or car, because then the cryptocur- Learn more about virtual rency might not qualify for capital asset currencies and related tax and How to Guide Clients treatment, thus your clients might not be financial planning considerations As a financial planning practitioner, how able to take a capital loss deduction. Best with the following resources: can you help clients who may have an practice would be to sell the cryptocur- “accession to wealth” resulting from a hard rency and then use the proceeds from Virtual Currencies and IRS fork or airdrop of cryptocurrency? the sale to purchase the personal-use Revenue Ruling 2019-24 Ask your clients if they have ever property. AICPA podcast with Ryan Firth transacted in virtual currency, because If your client is charitably inclined and Shehan Chandrasekera the IRS will most likely be asking taxpay- and wants to donate crypto, help him aicpa.org/interestareas/ personalfinancialplanning/ ers on Schedule 1 of Form 1040 for 2019,4 or her identify crypto assets that will offer cpeandevents/learning-library and because the agency has issued letters the highest charitable deduction possible,

to taxpayers who may have transacted in being mindful that crypto held for one year Cryptocurrencies: What Every 5 virtual currency in the past. You’ll prob- or less receives a deduction that is equal Tax Practitioner and Financial ably want to know about your clients’ to “the lesser of the taxpayer’s basis in the Planner Should Know crypto transactions before the IRS does. virtual currency or the virtual currency’s TXCPA Houston article by For those clients that have trans- fair market value at the time of the con- Ryan Firth acted in virtual currency, determine if tribution.” Also, remember that charitable houstoncpa.org/news/ they need to file an amended tax return deductions are subject to AGI limitations, details/2018/12/13/crypto currencies-what-every-tax- for any prior years. Help them determine and a qualified appraisal is required for practitioner-and-financial- whether they’ve constructively received donations greater than $5,000 in value. planner-should-know cryptocurrency as a result of a hard fork Much like technology and or airdrop. Be aware that the Bitcoin cryptocurrencies, the taxation of virtual Cryptocurrencies: network has had several hard forks, as currency is multi-faceted and ever- Issues and Best Practices have other cryptocurrencies. changing. Financial planners who stay Journal of Financial Planning Ensure taxpayers are properly abreast of regulatory developments with article by Ryan Firth tracking the cost basis of their crypto respect to virtual currency, such as IRS FPAJournal.org holdings (per FAQ A36, specific identifi- Revenue Ruling 2019-24, can add a great cation is allowed as a cost basis tracking deal of value to clients who transact in Should Cryptoassets Be a Part of a Client’s Portfolio? methodology). Many online basis cryptocurrencies. Journal of Financial Planning tracking software tools are available to article by Ryan Firth, Bobby both taxpayers and tax professionals that Endnotes Henebry, and Tyrone V. Ross Jr. aid in tax lot optimization strategies. 1. For the full text, visit irs.gov/pub/irs-drop/ FPAJournal.org Utilize tax loss harvesting to offset rr-19-24.pdf. For the FAQ, see irs.gov/individuals/ capital gains. Because virtual currency is international-taxpayers/frequently-asked- Tax Implications of Investing, deemed property, and not a security, the questions-on-virtual-currency-transactions. Trading, and Transacting in Cryptocurrencies wash sale rules likely do not apply should 2. Access historical data for Bitcoin at coinmarket Mercer Street blog post your client desire to purchase the same cap.com/currencies/bitcoin/historical-data/?s by Ryan Firth tart=20170801&end=20170801. And access crypto asset within the 30-day window. mercerst.com/blog Explore with your clients who want historical data for at coinmarketcap. to invest in cryptocurrencies the pos- com/currencies/bitcoin-cash/historical-data/?star sibility of using a tax-advantaged vehicle t=20170801&end=20170801. owners-advising-them-to-pay-back-taxes-file- such as a self-directed IRA, thereby 3. See this historical data at coinmarketcap.com/ amended-returns-part-of-agencys-larger-efforts. reducing the burden of basis tracking currencies/bitcoin-cash/historical-data/?start=20 and tax uncertainty surrounding virtual 171220&end=20171220. A version of this column was originally published by currencies. Don’t forget about prohibited 4. According to irs.gov/pub/irs-dft/f1040s1--dft.pdf. TXCPA Houston in the October/November 2019 edi- transactions in an IRA, though. 5. For more on this, see irs.gov/newsroom/ tion of the Forum Magazine, available at houstoncpa. Educate your clients about using irs-has-begun-sending-letters-to-virtual-currency- org/education/publications.

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