2019 Cryptocurrency Tax Guidance from the IRS

by Matt Metras, EA – Oct 11, 2019

After 5 years of radio silence, on October 9th, 2019, the IRS released some of the tax guidance we have been waiting for. This came to us in two forms:

  1. Revenue Ruling 2019-24 which deals with hard forks and “airdrops.”
  2. Updated FAQ that hasn’t been changed since the March 2014 initial guidance. The updated FAQ integrates the information in RR-19-24 and also includes some new information about accounting methods, gifts, donations, transferring between wallets, and determining “Fair Market Value” (FMV). The FAQ failed to address other much needed topics such as complex fork situations, lost or stolen coins or keys, Like-Kind (§1031) treatment, coins sent to the wrong address, foreign account reporting requirements, wash sales and unwanted coins.

Forks

The biggest news from this guidance is that any coin received as the result of a hard fork should be considered ordinary income under IRC §61. Coins must be reported as such based on the FMV of the coin at the time the owner has complete dominion and control AND the ability to dispose of the coin.* This is a very unfavorable position for taxpayers. If you’ve read my previous article on Forks, the IRS has gone with “Option 2”.

This means if you controlled your own BTC private keys on 8/1/17, you are required to recognize income in 2017 equal to the FMV of BCH at the time of the fork. However, if you held your BTC on Coinbase on 8/1/17, you did not have constructive receipt of the BCH until 12/20/17 when the price was much higher. If your exchange didn’t give you control of your BCH until 1/1/18, you would recognize fork as 2018 income.

This creates several problems. The first is determining timing. Do you exercise complete dominion and control at Block 1, Block 2, or some other point? Post fork pricing is typically volatile. On the first day of BCH trading (8/1/17), the price fluctuated between $210 and $426. Prices vary wildly by exchange and volume can be artificially manipulated. If you had your BCH on Coinbase, the first time you had dominion and control on Dec 20, 2017, the high trading price was $4,355.62.** That means if you and I each had one BTC on 7/31/17, and I kept mine in a private wallet, and you had yours on Coinbase, I would recognize $210 in income and you would recognize $4356, whether we wanted the BCH or not. Such inconsistent treatment seems to violate the taxpayers bill of rights to not pay more than the correct amount of tax and to a fair and just tax system.

It’s although worth noting Coinbase is currently being sued for allegedly allowing insider trading of BCH before it was open to the public, artificially inflating the trading price. It is easily conceivable that a malicious actor could fork a coin with an artificially inflated value, just for the purpose of creating taxable income for a coin holder.

A lack of market liquidity also does not impact the requirement to recognize income. Following the BCHABC/BSV fork in 2018, it was unclear for some time which would become the dominant blockchain. Some exchanges listed both coins, some only one. The RR/FAQ makes references to the legacy coin and the forked coin. This situation makes it difficult to determine which one is which.

Unwanted Forks

The IRS has indicated that it doesn’t matter if you want the forked coin or not, if you could have claimed it, it is income for tax purposes. In the 10 months following the Bitcoin Cash fork, Bitcoin had another 44 hard forks. All but four of them have turned out to be worthless. However, following the rules laid out in the FAQ, all 45 of these forks would need to be tracked, and recognized as income. This represents a substantial compliance burden for the average cryptocurrency user. Additionally, if forced to recognize these coins as income, it is possible the taxpayer would have phantom income they have to pay tax on. In theory, they would recognize a capital loss in an equal amount when they dispose of the coin, but what if you can’t dispose of the coin? If there is only one exchange for a coin, and it collapses, you technically own a coin that you recognized income on and can’t sell. You could “abandon” the coins, but a mechanism for that isn’t recognized for tax purposes.

Not knowing about the fork is also not a defense if it is considered “reasonable” that a taxpayer should have know about the fork, it is still income at the time of the fork. If you find out about the fork later, you must retroactively recognize that income.

If claiming the forked coin potentially exposes your private keys or would you to require installing 3rd party software that could pose a security risk, it is still income.

Soft Forks

Soft forks do not result in new coins, so there is no income to realize.

Airdrops

It’s important to note that the IRS uses the term “airdrop” in a way that is inconsistent with most of the crypto community. In the IRS context, an airdrop is any coin received that you didn’t intentionally acquire. This can mean an airdrop in the traditional sense, or any coin you receive (or could control with your private keys) following a hard fork. In either case, the airdropped coin is considered income. There is no “de minimus” for this. So if $1 worth of DumpsterCoin shows up in your wallet, the IRS expects you to report it.

Accounting Methods

The 2nd biggest piece of news in the new FAQ relates to permissible accounting methods. Your accounting method is how you identify which coin is being disposed of when it leaves your account. The default method is First-in, First-out (FIFO). This method can potentially create issues for the taxpayer’s record keeping (If I buy coin 1 on Jan 1 and hold in wallet A, and buy coin 2 on March 1 and hold in wallet B, and then later sell the coin in wallet B, FIFO accounting requires the user to sell coin 1 “on paper” even though you clearly still have it.) Additionally, this can require a taxpayer to recognize a larger gain for tax purposes than was actually realized.

Because of this, the IRS has allowed for the use of the Specific Identification method. A.37 tells us the standard to use specific ID is:

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.
Utilizing this method can be of substantial benefit to taxpayers.

Gifts and Donations

A.30-34 provide guidance on the treatment of cryptocurrency related gifts and donations. This treatment is consistent with gifts and donations of other personal property. There were no surprises here.

Coin-to-coin Exchanges

In the initial 2014 guidance, the IRS never explicitly stated that trading one coin for another was a reportable event. This created ambiguity around the application of Like-Kind*** Treatment, and if it was applicable to cryptocurrency. The IRS first explicitly defined that all coin to coin transactions are taxable in the 6173, 6174, and 6174-A letters sent out in the summer of 2019. This position has been reinforced in the FAQ (A.15)
Transfers of the same coin between wallets or exchange accounts you control are not taxable events.

What about the returns I already filed?

Revenue Rulings are “intended to inform both the taxpayers and the personnel of the Service as to the Commissioner’s position with respect to a particular issue thus ensuring that this issue will be handled uniformly throughout the country.” Basically, this is the IRS’ interpretation of the tax law that already exists (and existed when previous year’s returns were filed). It’s conceivable this will be the enforcement standard the IRS uses on previously filed returns.

If you filed a return that is not in compliance with the IRS position, you should consider amending. Discuss with your tax advisor the potential compliance costs in amending weighed against the risks of not. Consider if there are any benefits (such as using the specific ID method) when deciding. Everyone’s situation is unique, so it’s important to base your decision on your own specific situation.
It is likely some of there provisions will be challenged in court, so it could still be years before we have definitive answers on some of these topics.

If you would like to talk about your personal situation please Contact Us

*I was able to have a phone conversation with the IRS Office of Chief Counsel on 10/9/19 and asked many clarifying questions. This is why some of the language I use here does not directly match the Revenue Ruling as published. This information should not be considered substantial authority, or any kind of legal, tax or accounting advice. Consult your own adviser.

**According to FAQ A.25, if your coins are on an exchange, you are required to use the value on that exchange to determine FMV. If you don’t, you should use the value of the transaction if it had occurred on an exchange in a “reasonable and consistent” method to determine FMV.

***Like-Kind Exchanges under §1031 were restricted to only real property for tax years 2018 forward by the Tax Cuts and Jobs Act of 2017. The ambiguity only relates to transactions made before 12/31/17.