Long awaited guidelines from the IRS on how to tax a “hard fork” have recently been issued. The concept of a “hard fork” didn’t exist prior to July of 2017 when “bitcoin cash” was created.
IRS Revenue Ruling 2019-24 explains the “hard fork” as follows:
A hard fork is unique to distributed ledger technology and occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger.
Transactions like the “hard fork” were not possible before cryptocurrencies emerged and tax experts had been left to speculate about whether a “hard fork” is a taxable transaction or not. The introduction of Bitcoin Cash in August of 2017 is the classic example of a Hard Fork. Bitcoin issued Bitcoin Cash, a new cryptocurrency to each bitcoin owner. The new virtual currency issued was pro-rata to all bitcoin holders so each bitcoin owner continued to own the same percentage piece of the bitcoin pie.
To accountants this looks like a corporate stock split, the primary difference being that virtual currency and stock in a corporation are not quite the same thing. In a 2 for 1 stock split there usually is no usually no “accession to wealth” because the value of each share drops by 50% and the overall value of 1 old share is now divided into 2 shares having the same total value. A stock split is not a taxable transaction under our income tax laws.
However, under the corporate stock analogy, the “hard fork” also somewhat resembles a dividend, or a corporate distribution of earnings. Under longstanding tax principles, a dividend is generally taxable. So should a hard fork be treated like a stock split (not taxable), or like a stock dividend (taxable)?
The IRS ruling is that it depends on whether or not the taxpayer receives units of a new cryptocurrency (an “airdrop”) or not. The value of the new currency received in an “airdrop” is to be treated like a dividend and is taxable. If the “hard fork” is not accompanied by an “airdrop” or other receipt of a new cryptocurrency, the transaction is not taxable.
– Mark S Gleason CPA