Breaking Down the New IRS Cryptocurrency Tax Guidance
For the first time since 2014, the IRS has issued new cryptocurrency tax guidance in the form of a complete cryptocurrency FAQ and an official Revenue Ruling: 2019-24. This new guidance legitimizes many of the assumptions that were previously being made by leading crypto tax companies and tax professionals in the industry. The guidance also provides clarity on some of the gray areas within the world of cryptocurrency including the tax treatment of forks & airdrops, allowable cost basis methods, and rulings around cryptocurrency transfers.
Note - we provide an overview of cryptocurrency taxation and how cryptocurrency is taxed in our blog post: The Complete Guide to Cryptocurrency Taxes. It may be beneficial to read this before continuing.
New IRS Crypto Tax Guidance
The major clarifications and takeaways from the new IRS guidelines are discussed below.
Cryptocurrency Hard Forks
If a certain cryptocurrency that you are holding goes through a hard fork which “occurs when a cryptocurrency undergoes a protocol change resulting in a permanent diversion from the legacy distributed ledger”, the new forked cryptocurrency that you receive is taxed as income. Your cost basis in the newly received cryptocurrency becomes the income you recognized.
For example - If you held 2.5 Bitcoin in July of 2017, and received 2.5 Bitcoin Cash as a result of the bitcoin cash hard fork, you recognize this received 2.5 Bitcoin Cash as income at the fair market value of the bitcoin cash at the time it was received. If Bitcoin Cash was trading for $500 a piece that day, you would recognize income of $1,250 ($500 * 2.5). Your cost basis in this Bitcoin Cash becomes $1,250.
If you do not receive new cryptocurrencies after a hard fork, you will not have any taxable income. Source: A21, A22, A23, A24
Cryptocurrency Soft Forks
A cryptocurrency soft fork “does not result in the creation of a new cryptocurrency, meaning it does not result in any income.” So if your cryptocurrency goes through a protocol change but does create a new cryptocurrency - you don’t recognize any income. Source: A29
Cryptocurrency Air Drops
If you receive cryptocurrency from an airdrop (“a distribution of cryptocurrency to multiple taxpayers’ distributed ledger addresses”) you recognize income on this received cryptocurrency on the day/time it was received. The amount of income recognized should be determined using the fair market value of the cryptocurrency at the time.
If you did not receive any cryptocurrency when an airdrop event occurred, you do not recognize income as you did not receive the property.
Prior to this new guidance, it was unclear how taxpayers were to assign cost basis for their cryptocurrency assets. The IRS has officially clarified this topic in the new ruling.
Specific identification can be used as an accounting method for trading crypto assets. This means that taxpayers can select which units and lots of cryptocurrency they are selling at a given time as long as they can specifically identify them and support the cost basis of the units.
To specifically identify a unit of cryptocurrency, you must include the following information:
- The date and time each unit was acquired,
- Your basis and the fair market value of each unit at the time it was acquired,
- The date and time each unit was sold, exchanged, or otherwise disposed of, and
- 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
If you are unable to specifically identify your cryptocurrencies, you are to default to a first-in first-out (FIFO) basis. Source: A36, A38
You can use CryptoTrader.Tax and specific identification costing methods like LIFO to calculate your crypto gains and losses. You also have the ability to default to FIFO within the CryptoTrader.Tax reporting platform.
Taxpayers are required to maintain records that are sufficient to establish the positions taken on tax returns. Therefore, it’s best practice to keep records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.
CryptoTrader.Tax helps its users by providing them properly document the positions they take on their tax return with a complete audit trail report. This report documents every taxable event incurred as well as the associated transaction details. You can keep this audit trail for your records.
Cryptocurrency Transfers: Not Taxable Events
While this was already clarified previously, it’s worth repeating, and the new guidance reiterates that simply transferring cryptocurrency from one platform or from one wallet to another is NOT a taxable event.
“If you transfer virtual currency from a wallet, address, or account belonging to you, to another wallet, address, or account that also belongs to you, then the transfer is a non-taxable event, even if you receive an information return from an exchange or platform as a result of the transfer.” Source: A35
So even if you receive a 1099-K from your cryptocurrency exchange detailing your transfers, these events are not taxable and do not contribute to your capital gains or losses. This is good news for anyone who received notices 6174-A, 6173, CP2000, or other 1099-K’s.
It is actually this problem of cryptocurrency transfers and associated 1099-K’s that are make your tax liability appear extremely inflated. We have dubbed this the cryptocurrency tax problem here at CryptoTrader.Tax, and you can read more about why exchanges like Coinbase can’t give their users accurate tax information here.
Cryptocurrency Tax Software
Cryptocurrency tax software like CryptoTrader.Tax is built to automate the entire crypto tax reporting process, and all of the new IRS guidelines have already been built into the CryptoTrader.Tax tax reporting engine. You can generate your required crypto tax forms by simply connecting your exchanges, importing your trades, and generating your reports with the click of a button.
Simply import these reports into TurboTax, send them to your accountant, or file them yourself!
It is great to see the IRS provide clarity around cryptocurrency taxation and thus further legitimize the growing industry. Clear guidance from regulatory bodies will no doubt help with increased market adoption. When the rules are clear, everyone feels more comfortable playing the game.
Have any questions or comments? Just message us @CryptoTraderTax
Disclaimer - This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.