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IRS Issues New Virtual Currency Guidance and FAQs
Practical Law Legal Update w-022-4839 (Approx. 5 pages)
IRS Issues New Virtual Currency Guidance and FAQs
by Practical Law Finance
| Published on 17 Oct 2019 • USA (National/Federal) |
The Internal Revenue Service (IRS) issued new guidance on the tax treatment and reporting obligations for transactions involving virtual currency (VC), including a new revenue ruling addressing the tax treatment of cryptocurrency hard forks and airdrops. The IRS also released frequently asked questions (FAQs) on VC transactions for those who hold VC as a capital asset.
On October 9, 2019, the Internal Revenue Service (IRS) issued new guidance on the tax treatment and reporting obligations for transactions involving virtual currency (VC). The guidance included:
- Revenue Ruling 2019-24 (Rev. Rul. 2019-24), which addresses the tax treatment of cryptocurrency "hard forks" and "airdrops" (see Rev. Rul. 2019-24).
- Frequently asked questions (FAQs), which address VC transactions for those who hold VC as a capital asset (see FAQs).
The new guidance supplements the guidance that the IRS issued on virtual currency in 2014 (2014 Guidance), in which it announced its position that VC is treated as property for federal tax purposes (see Legal Update, Compensation Paid in Bitcoin is Subject to Employment Taxes under IRS Notice 2014-21).
The IRS notes in the press release accompanying the guidance that "it is aware that some taxpayers with virtual currency transactions may have failed to report income and pay the resulting tax or did not report their transactions properly." According to the IRS, it is addressing the potential non-compliance through a variety of efforts.
The IRS is also soliciting public input for further guidance in this area.
For information on the regulation of virtual currency and agency advisories on virtual currency, see Virtual Currency and Digital Asset Regulatory Tracker.
Rev. Rul. 2019-24
Rev. Rul. 2019-24 addresses two questions on the tax treatment of cryptocurrency hard forks and airdrops:
- Whether a taxpayer has gross income, under Section 61 of the Internal Revenue Code (Code), as a result of a hard fork of a cryptocurrency that a taxpayer owns, if the taxpayer does not receive new units of a new cryptocurrency.
- Whether a taxpayer has ordinary gross income under Section 61 of the Code as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer does receive units of the new cryptocurrency.
The IRS describes a "hard fork" as occurring when a cryptocurrency on a distributed ledger undergoes a change that results in a permanent diversion from the legacy or existing distributed ledger, resulting in a new cryptocurrency in addition to the legacy cryptocurrency. The IRS explains that following a hard fork, transactions involving the new cryptocurrency are recorded on a new distributed ledger, and transactions involving the legacy cryptocurrency are recorded on the legacy distributed ledger.
The IRS defines an "airdrop" as "a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers." According to the IRS, a hard fork that is followed by an airdrop would distribute the new cryptocurrency to addresses containing the legacy cryptocurrency.
The IRS states that a taxpayer does not have receipt of a cryptocurrency from an airdrop until the taxpayer is able to "exercise dominion or control over the cryptocurrency," or acquires the ability to "transfer, sell, exchange, or otherwise dispose of the cryptocurrency."
Rev. Rul. 2019-24 provides two hypotheticals to address the tax treatment of cryptocurrency hard forks and airdrops, and ultimately concludes that:
- A taxpayer does not have gross income as a result of a hard fork of a cryptocurrency that the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency.
- A taxpayer does have ordinary gross income as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency.
Under Section 61(a)(3), gross income includes gains from dealings in property, including "undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion," and is ordinary "unless it is gained from the sale or exchange of a capital asset or a special rule applies."
FAQs
The FAQs include 43 questions that address VC transactions for those who hold virtual currency as a capital asset. The FAQs are meant to expand upon the examples provided in the 2014 guidance.
The FAQs include the following guidance:
- If a particular asset has the characteristics of a virtual currency, regardless of the label applied, it will be treated as virtual currency for federal income tax purposes.
- When virtual currency is sold, a taxpayer must recognize any capital gain or loss on the sale, subject to limitations on the deductibility of capital losses.
- A gain or loss, when selling virtual currency for real currency, is the difference between the adjusted basis in the virtual currency and the amount received in exchange for the virtual currency. A taxpayer's basis, or cost basis, is the amount spent to acquire the virtual currency, including fees, commissions, and other acquisition costs in US dollars.
- When paying for a service using virtual currency, the gain or loss is the difference between the fair market value of the service and the adjusted basis in the virtual currency exchanged.
- If a taxpayer's cryptocurrency goes through a hard fork, but the taxpayer does not receive any new cryptocurrency, there is no taxable income. If a taxpayer's cryptocurrency goes through a hard fork that was followed by an airdrop, and the taxpayer does receive new cryptocurrency, then there is taxable income in the taxable year the cryptocurrency was received.
- To determine cryptocurrency's fair market value:
- when received through a platform for trading cryptocurrency, or a cryptocurrency exchange, the value of the cryptocurrency is the amount that is recorded by the exchange for that transaction in US dollars. Or, for an off-chain transaction, the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an on-chain transaction;
- when received in a peer-to-peer transaction, the value of the cryptocurrency is determined as of the date and time the transaction is recorded (or would have been recorded, if an off-chain transaction) on the distributed ledger;
- for a cryptocurrency that does not have a published value, the fair market value is equal to the fair market value of the property or services exchanged for the cryptocurrency when the transaction occurs.
- A taxpayer does not have income when a soft fork of cryptocurrency occurs, since a soft fork does not result in the creation of a new cryptocurrency.
- Virtual currency donated to a charity generally qualifies as a charitable contribution.
- Transferring virtual currency between wallets, addresses, or accounts belonging to a taxpayer are non-taxable events.
- Taxpayers that own multiple units of one kind of virtual currency can choose which units of virtual currency are deemed to be sold or exchanged if the taxpayer can specifically identify which units are involved in the transaction.
- Specific units of virtual currency can be identified either by:
- documenting the specific unit's unique digital identifier, such as a private key, public key, or address; or
- by records showing the transaction information for all units of a specific virtual currency held in a single account, wallet, or address.
- Sales and exchanges of virtual currency that do not specifically identify the units are deemed to have been sold or exchanged in chronological order beginning with the earliest unit of virtual currency purchased or acquired, or on a first in, first out (FIFO) basis.
The FAQs also provide information regarding the reporting and record maintenance requirements relating to transactions in virtual currency.
Update: On October 10, 2019, the IRS released a new draft Schedule 1 to Form 1040 that asks taxpayers about financial interests in virtual currency. The IRS also released draft instructions that include guidance for taxpayers on how to report financial interests in virtual currency on Schedule 1. The IRS included information about the draft Form 1040 in its October 11, 2019 bulletin, e-News for Tax Professionals Issue 2019-37.