In 2014, the IRS said that virtual currency, such as Bitcoin, is property and not currency (Notice 2014-21). Thus, individuals receiving payments in cryptocurrency held for investment means reporting them as property transactions on Form 8949 and Schedule D. Now the IRS has provided additional guidance by posting 43 FAQs (https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions). It also issued a new ruling with specific guidance on “hard forks,” “soft forks,” and “airdrops” (Rev. Rul. 2019-24).
- Hard forks occur when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger. This may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger.
- Soft forks occur when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency.
- Airdrops occur when there is a distribution of cryptocurrency to the ledger addresses (wallets) of multiple taxpayers or some other kind of transfer.
According to the IRS, if your cryptocurrency goes through a hard fork, but you don’t receive any new cryptocurrency, whether through an airdrop (a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses) or some other kind of transfer, you don’t have taxable income. If a hard fork is followed by an airdrop and you receive new cryptocurrency, you have taxable income in the taxable year you receive that cryptocurrency. This is ordinary income equal to the fair market value of the new cryptocurrency when it is received, which is when the transaction is recorded on the distributed ledger, provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency. Because soft forks do not result in the receipt of new cryptocurrency, you will be in the same position you were in prior to the soft fork, meaning that the soft fork will not result in any income to you.
The FAQs also explain how to report payments for services made in cryptocurrency, gifts of cryptocurrency, and charitable contributions of cryptocurrency.
Note: Schedule 1 for the 2019 Form 1040 or 1040-SR has a new question that must be answered: At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?