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IRS Takes on “Hard Fork” and “Airdrop” as Part of New Guidance on Virtual Currency

Monday, December 9, 2019   (0 Comments)
Posted by: Abbey Kwiat
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The Sidley Team

On October 9, 2019, the U.S. Internal Revenue Service (IRS) released frequently asked questions on virtual currency transactions (FAQ) and Revenue Ruling 2019-24 (Revenue Ruling). The long-anticipated guidance on virtual currency transactions primarily builds on previous guidance the IRS provided in Notice 2014-21. 


The FAQ generally expands on the guidance and examples provided in Notice 2014-21 and applies the same general tax principles to additional situations such as (i) payments for services using virtual currency, (ii) exchanges of virtual currency for property (including other virtual currency), (iii) gifts and charitable donations of virtual currency and (iv) sales of multiple units of one kind of virtual currency acquired at different times. Additionally, the FAQ gives examples on how to determine the fair market value of a cryptocurrency received on an exchange or otherwise (e.g., as part of a transaction that is either recorded or not recorded on a distributed ledger, a peer-to-peer transaction or the receipt of cryptocurrency with unpublished value). Both the FAQ and the Revenue Ruling address the tax treatment of two specific types of transactions, the occurrence of a “hard fork” (i.e., when a cryptocurrency undergoes a change that may result in the creation of a new cryptocurrency in addition to the legacy cryptocurrency) and an “airdrop” (i.e., when a taxpayer receives new units of cryptocurrency following a hard fork). The Revenue Ruling and the FAQ make clear that a taxpayer is taxed only if the taxpayer receives a new virtual currency, which requires that the taxpayer be able to exercise complete dominion and control over the new virtual currency. Thus, the tax treatment of virtual currencies is consistent with the tax treatment of other properties. 


Frequently Asked Questions on Virtual Currency Transactions 

Similar to Notice 2014-21, the FAQ applies only to virtual currency that has an equivalent value in real currency or acts as a substitute for real currency (convertible virtual currency).1 The FAQ covers all types of convertible virtual currency, regardless of the label applied, under the tax definition of a virtual currency, such as digital currency and cryptocurrency (i.e., a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain).  

The FAQ reaffirms Notice 2014-21 in providing that virtual currency is treated as property for U.S. federal income tax purposes and general tax principles applicable to property transactions apply to virtual currency transactions. For example, when a taxpayer receives a virtual currency in exchange for services, whether or not through an exchange platform, the taxpayer is required to include the fair market value of the virtual currency in gross income as measured in U.S. dollars at the time of receipt. If a taxpayer acquires virtual currency on an exchange, the taxpayer’s basis in the virtual currency will be equal to the amount spent to acquire the virtual currency (including fees, commissions and other acquisition costs) as measured in U.S. dollars at the time of acquisition. The taxpayer’s holding period starts on the day after the virtual currency is received or acquired. If a taxpayer holds virtual currency as a capital asset, upon the sale of the virtual currency, the taxpayer will recognize capital gain or loss that will be either long-term or short-term depending on the taxpayer’s holding period.


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