On Oct. 9, the IRS issued Revenue Ruling 2019-24 and frequently asked questions on taxing virtual currency. The previous IRS guidance on virtual currency was in March 2014 in Notice 2014-21, which concluded that convertible virtual currency is treated as property for federal tax purposes. This finding is unchanged in the new guidance.
Revenue Ruling 2019-24
The revenue ruling is focused on hard forks, which, the ruling states, occur when a distributed ledger or blockchain encounters a protocol change that results in a permanent split in the chain. The split results in holders of cryptocurrency in the legacy chain receiving an equal amount of cryptocurrency from the new chain.
The ruling is understood to support the IRS’ view that a taxpayer has ordinary income on receipt of any new units of cryptocurrency following a hard fork. The amount of income received equals the fair market value (FMV) of the new cryptocurrency at the date and time when the transaction is recorded on the distributed ledger.
Under the ruling, a taxpayer has receipt when the taxpayer has dominion and control over the cryptocurrency – meaning the taxpayer can transfer, sell, exchange, or otherwise dispose of the cryptocurrency. The ruling also provides that the taxpayer does not have dominion and control if, at the time of the hard fork, the taxpayer’s third-party cryptocurrency exchange does not immediately support the new cryptocurrency. However, if the exchange later supports the new cryptocurrency, the taxpayer will have dominion and control at that time.
The FAQs address issues including the following:
- The term “virtual currency” includes various types of convertible virtual currency used as a medium of exchange, such as digital currency and cryptocurrency, regardless of the label used.
- Because a soft fork does not permanently split the chain or create new cryptocurrency, there is no income recognition as a result.
- In computing gain or loss, taxpayers may use either specific identification or the first-in, first-out method to track which cryptocurrency was sold or exchanged.
- If cryptocurrency is acquired with fiat currency, the basis of the cryptocurrency is the amount spent in U.S. dollars to acquire the virtual currency, including fees, commissions, and other acquisition costs. If cryptocurrency is received in exchange for property or services, the basis of the cryptocurrency is the FMV of the property or services in U.S. dollars at the time of receipt.
- If a cryptocurrency transaction is facilitated by a cryptocurrency exchange, the FMV of the cryptocurrency is the amount in U.S. dollars recorded by the exchange on which the cryptocurrency was trading at the date and time of the transaction.
- For peer-to-peer or other types of cryptocurrency transactions where no cryptocurrency exchange is involved, the FMV is determined at the date and time the transaction is recorded on the distributed ledger or the date and time it would have been recorded on the ledger if it had been an on-chain transaction. An analysis of worldwide indexes at an exact date and time may be evidence of FMV.
- Cryptocurrency received as a bona fide gift is excluded from gross income, and the recipient’s holding period includes the holding period of the original holder.
- If the holding period of donated cryptocurrency is more than one year, the charitable contribution deduction is generally the FMV at the time of donation. If the holding period is one year or less, the deduction is the lesser of the taxpayer’s basis in the cryptocurrency or its FMV at the time of donation.
- Exchanging one virtual currency for another virtual currency is a taxable event.
- Transfers between wallets, addresses, or accounts of the same taxpayer do not result in income recognition.
The recent guidance is retroactive and does not provide any safe harbor or transition relief. It comes on the heels of the IRS announcing that it sent 10,000 letters to taxpayers that it believes have failed or might have failed to comply with their federal tax obligations regarding transactions involving virtual currency. The IRS obtained information on these transactions through a summons issued to a large virtual currency service provider. The IRS said that it plans to send more letters.
The IRS added a new question to the draft of Schedule 1 of the 2019 Form 1040, “Additional Income and Adjustments to Income,” that requires taxpayers to disclose whether they received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency at any time during 2019.
The IRS is working on guidance to require information reporting on virtual currency under IRC Section 6045. In addition, the IRS is reviewing whether foreign account reporting under the Foreign Account Tax Compliance Act and the Report of Foreign Bank and Financial Accounts is applicable to virtual currency. Another outstanding issue that needs to be addressed is whether like-kind exchange treatment, prior to its repeal by the Tax Cuts and Jobs Act of 2017, applied to an exchange of one type of virtual currency for another.
The complexity and increased enforcement and disclosure in this area make it crucial that taxpayers consult with their tax advisers on the proper tax treatment for cryptocurrency transactions.