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Friday, October 11, 2019

IRS Releases First Crypto Tax Guidance In 5 Years


On October 9, the IRS finally released additional guidance on cryptocurrency (see Rev. Rul. 2019-24) – their first update on the topic since 2014. At first glance, the guidance doesn’t seem to demand a significant departure from how we have been advising clients to treat their crypto and digital assets. Therefore, instead of providing a high-level overview of the changes like many other firms, we’ve chosen to highlight a few of the top questions we saw come through our inboxes, as well as across social channels.

Fork in the Road

One of my cryptocurrencies went through a hard fork followed by an airdrop and I received new cryptocurrency. Do I have income?

If a hard fork is followed by an airdrop and a person (the “coin holder”) receives new cryptocurrency, the coin holder will have taxable income in the taxable year they receive that cryptocurrency. What is important here is that the specifics are somewhat ambiguous on what the IRS means by the term “receive”.

The requirement is that the coin holder has “dominion and control over the cryptocurrency so that the coin holder can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.” In other words, if the fork and airdrop occur, the qualifying factor is that the coin holder needs to have the ability to sell the newly received property. The ability will, in most cases, be the automatic consequence of the owner holding the private keys to the coin that is being forked (e.g., on Bitcoin- and Ethereum-based chains). It is important to note that there is no requirement for the coin holder to take any steps in that process. The coin holder may ignore the entire process, and still have a taxable income event. This puts a lot of burden on the coin holder.

Blockchains don’t offer the ability for coin holders to “reject” newly airdropped coins, similar to how they could reject a property donation, if it was offered. Forks and subsequent airdrops simply occur when someone decides they want to make it happen. The resulting token is digitally dropped without the approval of (or even the knowledge of) the coin holders of the original.

Of course, beneficiaries do have the ability to reject property, gifts, interests, inheritances, wills, trusts, etc. through a Disclaimer of Property Interest, but certain state law conditions must be met for this to be effective. For example, the disclaimer must be complete and not partial, and it has to be documented and potentially court-approved. However, in the world of almost instant airdrops, it seems unlikely this administrative process would be a solution.

More likely, coin holders will use a service for airdrop monitoring and handling. Wallets, custodians and exchanges could add features that allow coin holders to track and dispose of airdropped coins in an automated way, unless coin holders decide otherwise. These features would ensure the tax liability would never exceed the proceeds of the airdrop.

Cost Basis - Freedom to Choose

The regulation clarifies how to identify specific units, allowing coin holders to choose which units they are disposing of and in what order. Essentially, this means that all exchanges, DEX and OTC solutions will track the date and time and the basis and full market value (FMV) at the time of acquisition, sale or disposal.

How do I identify a specific unit of virtual currency?

Coin holders may identify a specific unit of virtual currency either by documenting the specific unit’s unique digital identifier (e.g., a private key, public key and address), or by records showing the transaction information for all units of a specific virtual currency (e.g., bitcoin) held in a single account, wallet or address. This information must show:

  1. the date and time each unit was acquired,
  2. your basis and the fair market value of each unit at the time it was acquired,
  3. the date and time each unit was sold, exchanged, or otherwise disposed of, and
  4. the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.

Lacking “de minimis” Exemption

One item we were hoping the IRS guidance would include was a “de minimis” exemption. Since this didn’t happen, all cryptocurrency transactions will result in taxable events. This is particularly troubling in light of stablecoins that are not US dollar-backed (e.g., Libra). Coin holders will end up with small taxable events if the basket of currencies has fluctuated from the US dollar between the moment they bought Libra and disposed of it (i.e., bought something with Libra). The administrative burden associated with this could hinder smooth mass adoption.

What’s Next?

We’ve had many clients receive IRS letters of non-compliance on the virtual currency transacting in the past months. With the publication of the new guidance, it is expected more users of virtual currency could receive these letters. Many users may not have known how to report airdropped coins, or they simply weren’t monitoring them. Before deciding if you need to amend any previous years’ returns, you should speak to your tax professional. Or, if you would like to discuss concerns related to your specific tax situation with one of our experts, do not hesitate to reach out to the following:

Andries Verschelden
Partner
Practice Lead, Blockchain

David Sordello, CPA
Head of Tax

Nick Gibbons, CPA
Tax Director

As with any new guidance, we’re still working through some of the details. In particular, we’re working on an upcoming overview of how crypto investors can utilize this new guidance to support optimal tax planning strategies such as basis optimization, opportunity zone investments and more.

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