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Cryptocurrency Transactions – New IRS Guidelines

The Internal Revenue Service (IRS) has issued new guidance for taxpayers engaging in transactions involving cryptocurrency.  The recent IRS Revenue Ruling 2019-24 focuses on the tax treatment of a cryptocurrency hard fork.  In addition, the FAQs on Virtual Currency Transactions address several topics and how to determine the fair market value.

The guidance in the recent Revenue Ruling addresses two questions:

  • Does a taxpayer have gross income under §61 of the Internal Revenue Code as a result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency?
  • Does a taxpayer have gross income under §61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency?

A hard fork occurs when cryptocurrency on a distributed ledger undergoes a shift.  A hard fork may result in the creation of a new cryptocurrency.  Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger, and transactions involving the former cryptocurrency continue to be recorded in the prior distributed ledger.

The Revenue Ruling makes it clear that a taxpayer does not have gross income as a result of a hard fork if the taxpayer does not receive units of a new cryptocurrency. The Revenue Ruling also makes clear that a taxpayer does have gross income – characterized as ordinary income – if the taxpayer receives units of new cryptocurrency as the result of an airdrop following a hard fork.  In contrast, when a soft fork occurs (when a distributed ledger undergoes a shift that does not result in the creation of a new cryptocurrency), the soft fork will not result in income.

In the case of virtual currency, if the taxpayer doesn’t have control over the asset, meaning the currency is not immediately credited to the taxpayer’s account at the cryptocurrency exchange, a tax issue may arise. If the taxpayer later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer is treated as receiving the cryptocurrency at that time.

Finally, the FAQs make clear that taxpayers are required to maintain excellent records to establish positions taken on tax returns. This is always true, no matter whether you’re dealing with cryptocurrency, cash, or diamonds. You should maintain records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.

The need for record-keeping is particularly acute since the IRS is targeting non-compliance through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.  In July of this year, the IRS began mailing letters to taxpayers who may have failed to report or misreported transactions involving virtual currency. Those taxpayers may be liable for tax, penalties, and interest. In some cases, taxpayers could be subject to criminal prosecution.

Spicer Jeffries’ tax department is available if you have questions regarding cryptocurrency and related tax regulations.