Taxation of Cryptocurrency Received on Hard Fork : What , When & How ?

The cloud of mystery over the rule of taxation of cryptocurrency received by a person was removed when iRS issued IRS Revenue Ruling 2019-24.Now , it is known what will happen when you receive any cryptocurrency due to hard fork implementation on a blockchain network. This post is therefore entirely devoted to the taxation of virtual currency on account of a hard fork of a blockchain network.

What is a hard fork?

Before we proceed to hard fork, let us first understand what a fork is. A fork happens whenever a community of a specific blockchain changes the blockchain’s protocol by producing a second blockchain that shares all of its histories with the original but is headed off in a new direction.

Hard forks can occur for various reasons, including disagreements among developers and users about the future direction of a cryptocurrency, security concerns, or the need to make significant changes to the code to improve the network.

Two types of fork

1. Soft fork: A soft fork sets a new standard agreeable to all. A soft fork does not create a new separate blockchain network. So, no new cryptocurrencies are issued on account of a soft fork. For this reason, there may not be any taxable events when a soft fork is implemented on a blockchain network.

• Hard fork: When a hard fork happens, the blockchain splits into the original blockchain and an entirely new version blockchain following a new set of rules. It creates coins or tokens for the operation of the new version of the blockchain network.

Examples of the famous cryptocurrency hard forks

Here are the top four such cryptocurrencies which got birth on a hard fork of a blockchain

1. Bitcoin Cash (BCH): Bitcoin Cash was created in 2017 as a fork of Bitcoin. Bitcoin Cash has since forked several times, resulting in different versions of the coin, such as Bitcoin SV (BSV).
2. Ethereum Classic (ETC): Ethereum Classic was created in 2016 due to a contentious hard fork of the Ethereum blockchain. Ethereum Classic is the original Ethereum chain, operating on a Proof-of-Work consensus algorithm.
3. Litecoin Cash (LCC): Litecoin Cash was created in 2018 as a fork of Litecoin, which itself is a fork of Bitcoin. 
4. Bitcoin Gold (BTG): Bitcoin Gold was created in 2017 due to a hard fork of the Bitcoin blockchain. 

Taxable Events on Hard Fork

Thus, whenever new crypto coins or tokens generated on a blockchain’s hard fork are distributed to the community members of the original blockchain on which the hard fork was implemented, the issue of taxation of the value of new cryptocurrency in the hand of community members will arise. In other words, receiving new crypto coins from the new blockchain network is taxable as per IRS Revenue Ruling 2019-24.

Taxation of cryptocurrency received on the hard fork

The revenue procedure 2019-24 states that a receipt of cryptocurrencies due to hard fork in the wallet of a person is a taxable event. It means that an individual or business must include the value of new cryptocurrency as income in the year of receipt. The value of the new cryptocurrency is determined by its fair market value at the time it is received. 

This means that if an individual or business holds 1 Bitcoin (BTC) before a hard fork, they will have the same amount of the new cryptocurrency after the hard fork. For example, if the fair market value of the new cryptocurrency is $1,000, the individual or business will have to report $1,000 as income on their tax return.

The Revenue Ruling 2019-24 has in fact gave following example to make its ruling:

Situation 2: B received a new asset, Crypto S, in the airdrop following the hard fork; therefore, B has an accession to wealth and has ordinary income in the taxable year in which the Crypto S is received. See §§ 61 and 451. B has dominion and control of Crypto S at the time of the airdrop, when it is recorded on the distributed ledger, because B immediately has the ability to dispose of Crypto S. The amount included in gross income is $50, the fair market value of B’s 25 units of Crypto S when the airdrop is recorded on the distributed ledger. B’s basis in Crypto S is $50, the amount of income recognized.

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Key Points on taxation of cryptocurrency received on hard fork

1. It is property under the Internal revenue Code

If a hard fork creates a new cryptocurrency, the new cryptocurrency will be treated as property for tax purposes. All the taxation laws and rules that apply to a “property” as defined under section 317(a) of the Internal Revenue Code shall apply to new cryptocurrencies received on the hard fork. 

IRC § 317(a) Property — For purposes of this part, the term “property” means money, securities, and any other property; except that such term does not include stock in the corporation making the distribution (or rights to acquire such stock).

So, when you sell, barter, trade, or exchange at a higher price than your basis, there will be either short- or long-term capital gains depending upon the cryptocurrency holding period before sale or trade.

2 Receipt is income in the year of receipt

A taxpayer who receives a new cryptocurrency due to a hard fork will have taxable income equal to the new cryptocurrency’s fair market value (FMV) when it is received. The FMV value will be includible as income in the tax year you receive the cryptocurrency.

IRS, in its Revenue Ruling 2019-24 has given the following example of treatment of receipt of cryptocurrencies on hard fork.

3. FMV to be determined with crypto exchange rate

The fair market value of the new cryptocurrency will be determined by the exchange rate on a cryptocurrency exchange that is available to the taxpayer.

4. Holding period of cryptocurrency

The holding period of a “property” determines whether it is a short-term or long-term capital asset. So, the day the cryptocurrency is transferred to a person is the day the holding period will be counted. 

If you keep the cryptocurrency received on the hard fork for below 12 months, it is a short-term capital asset. So selling or trading within 12 months shall e short-term capital gains, and the gain or loss will be long-term if sold after holding for more than 12 months.

What happens when the crypto received on the hard fork is sold or transferred?

As earlier written, there will be capital gains or loss. The computation of capital gains or losses will be done as under :

• Capital Gains/Loss = Sale /transfer consideration  minus the basis (FMV value that was earlier considered income )
• The holding period of crypto before the sale will decide whether is short-term or long-term. 

The record maintenance requirement for the cryptos received on the hard fork under 

Those engaged in cryptocurrency transactions should maintain detailed records of their transactions, including hard forks and the resulting new cryptocurrencies received. The best way is to use crypto accounting software.This will remove the headache of keeping records of the trade, sales, or investments in cryptocurrencies, as many of them are synced documents with various popular wallets.