After months of anticipation, the IRS has finally released its new cryptocurrency tax guidance through Rev. Rul. 2019-24 and an FAQ. Specifically, this new revenue ruling clarifies: 1) proper tax calculation methods; 2) the tax treatment of hard and soft forks; 3) proper sources for pricing data; 4) cost basis assignment on gifted crypto; and 5) taxpayers’ responsibilities.
1) Proper Tax Calculation Methods
Buried in the FAQ is arguably the most interesting guidance released. Taxpayers may now either use First in First out (FIFO) or specific identification for calculating cost basis. Notably, the IRS does not list Last in First out (LIFO) or any other cost basis calculation method as acceptable.
TaxBit’s tax experts have always held the position that LIFO calculation on cryptocurrency transactions was too high of an audit risk for our users, so we chose not to offer that method. All of TaxBit’s tax calculations are in line with the IRS’ latest ruling. Taxpayers who filed with TaxBit will therefore not be required to amend their returns based on using an improper tax calculation method.
The IRS now allows specific identification as a proper cost basis assignment method. Taxpayers may use specific identification if they can show the specific unit’s unique digital identifier such as a private key, public key, and address, or by records showing the transaction information for all units of a specific virtual currency, such as Bitcoin, held in a single account, wallet, or address. Taxpayers can therefore use specific identification to optimize their taxes. If the required information to specifically identify an asset is not discernable or optimal, then FIFO will be used.
2) Tax Treatment of Forks
The new revenue ruling focuses heavily on the tax treatment of hard and soft forks. Essentially, a hard fork that results in a new coin being airdropped into your wallet is now treated as income equal to the fair market value at the time it is received. Soft forks do not result in a new asset and therefore don’t have tax consequences.
A) Hard Forks
Some view treating hard forks as income as unfair in scenarios when a taxpayer may not have wanted to receive a forked asset. For example, anyone who owned Bitcoin Cash (BCH) on November 15, 2018 may have received Bitcoin Satoshi’s Vision (BSV) as a result of the hard fork. Many taxpayers may not have wanted to own BSV and must now pay ordinary income tax at the value at the time of receipt. This may be especially unfair if the coin drops substantially in value soon after you receive it.
B) Soft Forks
Soft forks occur when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and therefore does not result in the creation of a new cryptocurrency. Soft folks are not taxable because you are not receiving new cryptocurrency.
3) Proper Pricing Data
The new IRS guidance clarifies that if you purchase cryptocurrency on an exchange then you are required to look to that specific exchange for pricing data. Solely using price aggregators such as Coinmarketcap is no longer acceptable. TaxBit pulls pricing data exchange by exchange when available, thus fulfilling this requirement.
If you engage in a peer to peer transaction or one that did not involve an exchange, then the IRS will accept as evidence of fair market value the value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time. TaxBit fulfils this requirement by using legitimate and comprehensive pricing aggregators in accordance with IRS guidance.
4) Gifted Cryptocurrency
Traditional rules that are applicable to equities also apply for gifting cryptocurrency. There will be no tax consequences if you are the gifter of cryptocurrency. The receiver of the gift will not receive income. Rather, if the receiver has a gain then they take their gifter’s cost basis in the asset. If the cost basis cannot be determined then it is $0.
If the gifted cryptocurrency is now less than the gifter’s basis then the giftee’s basis is the lesser of the gifter’s basis or the fair market value at the time of the gift.
5) Taxpayer’s responsibilities
The Internal Revenue Code and regulations require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns. You should therefore maintain, for example, records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency. If you connect your exchanges through TaxBit’s supported API’s or upload a trade history CSV file from a cryptocurrency exchange then this requirement will be satisfied.
This new guidance brings cryptocurrency tax rules even further aligned with the tax rules of equities. TaxBit’s tax experts have always analogized to the tax rules of equities when making assumptions on how the IRS will treat cryptocurrency. As such, TaxBit’s software has been calculating taxes in accordance with the new guidance. With that said, TaxBit will further enhance its product to better substantiate evidence of transactions (i.e; visibility of transaction IDs, blockchain records, etc.) in order to maintain full audit evidence and legally reduce users’ taxes.
-Written by Cryptocurrency Tax Attorney Justin Woodward