IRS Clarifies Taxability of Cryptocurrency in First Related Guidance Since 2014

On October 9, 2019, the IRS released Revenue Ruling 2019-24 (Rev. Rul. 2019-24) to provide clarity on the taxability of cryptocurrency when it’s transferred via hard forks or airdrops.

Along with the ruling, the IRS also issued Frequently Asked Questions (FAQs) on Virtual Currency Transactions, providing 43 questions and answers for those seeking guidance. This was the first guidance issued by the IRS since 2014.

The following is an overview of updates and implications for businesses and individuals.

Background

On May 16, 2019, the IRS issued a letter acknowledging that additional cryptocurrency guidance was needed and would be forthcoming. A few months later, the IRS issued over 10,000 notices in three varieties—Letter 6173; Letter 6174; Letter 6174-A—to various taxpayers with accounts on crypto exchanges.

However, these letters were only the precursor to the main guidance—Rev. Rul. 2019-24 and the accompanying FAQs. These updates show that the IRS is taking steps to address some of grey areas related to tax treatment of cryptocurrency, demystifying areas of the law that have historically concerned taxpayers and practitioners.

New Guidance

Rev. Rul. 2019-24

There’s been plenty of speculation from tax practitioners regarding whether cryptocurrency should receive ordinary or capital-gain treatment if it’s received from an airdrop as the result of a fork.

According to Rev. Rul. 2019-24, the IRS believes these transactions should be characterized as ordinary income. The ruling goes on to provide examples showing that ordinary, recognized income would be the tax basis to the taxpayer if they later sell the cryptocurrency. Many taxpayers were likely hoping for a more favorable ruling from the IRS.

Within the ruling, the IRS also heavily focused their efforts on defining various cryptocurrency terms. Here are a few of the terms the IRS highlights in its latest—and only—revenue ruling on cryptocurrency.

  1. Virtual currency. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the US dollar or a foreign currency.
  2. Foreign currency. Foreign currency is the coin and paper money of a country other than the United States. The currency must be designated as legal tender, circulated, and customarily used as a medium of exchange.
  3. Cryptocurrency. Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Units of cryptocurrency are generally referred to as coins or tokens.
  4. Distributed ledger technology. This technology uses independent digital systems to record, share, and synchronize transactions. These details are recorded in multiple places at the same time with no central data store.
  5. Hard fork. A hard fork occurs when a cryptocurrency on a distributed ledger undergoes a protocol change, resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new coin on a new distributed ledger in addition to the legacy coin or ledger. An airdrop sometimes occurs after a hard fork.
  6. Airdrop. An airdrop is a way to distribute units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency.
  7. Constructive receipt. These receipts prove a taxpayer’s ability to exercise dominion and control. If a taxpayer doesn’t have the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer doesn’t have constructive receipt.

The FAQs

The IRS’s FAQs expand upon some of the examples from Notice 2014-21 and supplement guidance issued in 2014. The FAQs clarify questions such as:

  • How is virtual currency treated for federal income tax purposes?
  • Will I recognize a gain or loss when I sell my virtual currency for real currency?
  • How do I calculate my gain or loss when I sell virtual currency for real currency?

These FAQs will likely provide much-needed insight into cryptocurrency tax matters, such as choosing an appropriate method for accounting for tax basis, receiving a deduction for donating cryptocurrency to a not-for-profit, and determining what happens when cryptocurrency is moved from one wallet to another.

For the full list of FAQs, visit the IRS website.

Updated Draft Forms

At the time of this writing, an updated 2019 version of the Form 1040, Schedule 1, and instructions—dated December 20, 2019—can be found on the IRS website. The updated schedule includes a question for taxpayers that asks, “At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” It then requires filers to check yes or no.  

Key Questions

If a taxpayer owns cryptocurrency that forked, asking the following questions can help reveal if there’s a taxable event that should be reported.

  • Did a hard fork occur?
  • Did an airdrop occur?
  • Do I have constructive receipt?
  • Will I have constructive receipt of the cryptocurrency in the future?
  • Do I have ordinary or capital gains?
  • What is the tax basis of the cryptocurrency I received from an airdrop as a result of a hard fork?

Rev. Rul. 2019-24 addresses each of the above questions, including the character of the gain to the taxpayer.

Takeaways

With much-needed IRS guidance on hard forks and airdrops finally issued, cryptocurrency holders can finally relax, knowing that they’re operating in compliance with the IRS’s current guidance.

That said, there are still many unanswered cryptocurrency-related questions, and more guidance is needed. Guidance may continue to fall behind the burgeoning, fast-paced cryptocurrency and blockchain industry. New ways to earn revenue, such as staking, may be next on the wish-list for IRS clarification.

Additionally, state and local jurisdictions will need to address state nexus rules, apportionment, and sourcing when it comes to trade or business activities, such as mining. At least for now, the IRS is working hard to push out guidance, and there is likely much more to come.

We’re Here to Help

For more information about Rev. Rul. 2019-24, the IRS’s FAQs on Virtual Currency Transactions, or how guidance may impact individuals and businesses, contact your Moss Adams professional.