Some cryptocurrencies operate by consensus amongst that cryptocurrency’s community. When a significant part of the community wants to do something different they may create a ‘fork’ in the blockchain. There are two types of forks, a soft fork and a hard fork. A soft fork updates the protocol and is intended to be adopted by all. No new tokens, or blockchain, are expected to be created and there is no impact on the tax position.
A hard fork is different and can result in new tokens coming into existence. Before the fork occurs, there is a single blockchain. Usually, at the point of the hard fork, a second branch (and therefore a new cryptocurrency) is created. The blockchain for the original and the new cryptocurrency have a shared history up to the fork. If an individual holds tokens of the cryptocurrency on the original blockchain they will, usually, hold an equal number of tokens on both blockchains after the fork.
The most famous forking event happened in 2017 when the bitcoin blockchain forked between BTC (Bitcoin) and BCH (Bitcoin Cash), anyone who owned BTC prior to the hard fork automatically received the new BCH tokens afterward.
In the US, there is still some uncertainty about the correct tax treatment for the coins received after a hard fork. What is known from the IRS's official guidance on Hard forks (found in their Crypto FAQs under question 23) is that the new cryptocurrency received as a result of the hard fork should be recorded as income. However, this should only be recorded as income when the following requirements are met:
"A23. When you receive cryptocurrency from an airdrop following a hard fork, you will have ordinary income equal to the fair market value of the new cryptocurrency when it is received, which is when the transaction is recorded on the distributed ledger, provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency."
Therefore, if you have cryptocurrency on an exchange that did not distribute any proceeds from a hard fork, this shouldn't constitute a taxable event as you do not have control over the cryptocurrency.
If you do have dominion and control over the cryptocurrency received from a hard fork, you should do as follows:
- Record it as ordinary income at fair market value (usually the price on any major exchange) at the time it is received.
- When you dispose of the cryptocurrency, use the value recorded as income at the time of the hard fork as the cost basis of 'acquiring' the cryptocurrency
Forks can be a confusing area for crypto taxation, so it is important to pay close attention to these matters in order to correctly calculate your cryptocurrency taxes. Thankfully, Recap supports all major hard forks and will calculate all of this on your behalf! Give it a try today for free by clicking the button below:
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Disclaimer: This article is intended as an informative piece. This is not accounting or tax advice. Please speak to a qualified tax professional about your specific circumstances before acting upon any of the information in this article.