Those in the cryptocurrency world have been anxiously awaiting definitive guidance regarding the taxation of virtual currency and until recently there has only been one document and it was pretty limited at best. There have been debates throughout the tax professional world about how to handle transactions, what was taxable and what wasn’t. The most confusing concept is what cryptocurrency or virtual currency as the IRS calls it, has been the character of crypto.
Most traders of cryptocurrency consider it an alternate form of money, not backed by any government valued by the trade at the moment. More and more businesses are accepting virtual currency for goods and services, adding to the perception of virtual currency as money.
The IRS doesn’t see it the same way. They see virtual currency as property subject to the same rules of taxation as gold and silver. There has been some noise about the SEC seeking to treat virtual currency as securities, especially in light of appearance of cryptocurrency trading platforms both in the US and in other countries and forking activity (defined below) which looks much like a stock split.
The IRS has stood firm on their position. This is significant because the treatment of securities has special rules, the most common of which is the wash sale rule that denies a loss deduction for a sale and repurchase within 30 day. So at least for now, without Congress passing new legislation, cryptocurrency will continue to be property.
With that backdrop, let’s discuss the IRS’s newest guidance Revenue Ruling 2019-24. This ruling addressed two significant issues, both regarding a hard fork of a cryptocurrency owned by a taxpayer. For those unaccustomed to trading in cryptocurrency, a hard fork is when the currency is split, and two currencies are formed designed to be incompatible with each other.
Both questions ask if a taxable event occurs at the hard fork. The difference is whether there is an airdrop involved. An airdrop is a means of distributing units of cryptocurrency. In the first situation, there was no airdrop and in the second situation, an airdrop occurred. In short, does a taxpayer have gross income under § 61 of the Internal Revenue Code (IRC) in either of these situations.
Revenue Ruling 2019-24 starts by restating their definition of virtual currency as opposed to fiat currency such as the dollar or a foreign currency. The ruling also defines terms and gives the background of the currency. The ruling gives an example for each situation, followed by a description of the law and analysis by an IRS attorney.
The results of this analysis by Ms. Sinno, Esq of the Office of Associate Chief Counsel is that in the first case, where there was no airdrop, the taxpayer does not have gross income under § 61 because he did not receive any more cryptocurrency. In the second case where there was an airdrop, the taxpayer did receive more cryptocurrency and as such has income under § 61 of the IRC. This is important because the airdrop is taxed as income, not a capital gain.
This is a very limited ruling addressing one issue with two variations. This is normal for such rulings. If you are using cryptocurrency in any way or even considering doing so, please talk to a competent professional who has specialized training in this relatively new frontier that is cryptocurrency.