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Cryptocurrency Industry and Investors Receive New Guidance on Key Tax Issues: Hard Forks, Airdrops, and Other Virtual Currency Transactions Addressed by IRS

October 10, 2019

This week the Treasury Department released long-awaited guidance on the tax treatment of virtual currency transactions for investors, employees and contractors receiving cryptocurrency as compensation, cryptocurrency trading platforms, and other stakeholders. That guidance includes a determination that a “hard fork” by a cryptocurrency generally does not result in a tax liability for holders of that cryptocurrency, but a holder will be subject to tax if that hard fork is accompanied by an “airdrop.” In addition, the IRS has provided an updated series of frequently asked questions regarding common virtual currency issues, including additional guidance on determining the fair market value (FMV) of cryptocurrency. This guidance comes five years after the release of Notice 2014-21 (the “2014 Notice”), which explained the basic treatment of virtual currency under US tax law, but left many questions unanswered. Given the IRS’s recent pronouncements suggesting increased scrutiny of virtual currency transactions, this new guidance is a welcome development for taxpayers involved in those transactions, but the guidance is not comprehensive, and many important questions still remain.

Existing Guidance

The 2014 Notice defined “virtual currency” as a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. The 2014 Notice established the IRS’s basic position that virtual currency is not treated as foreign currency for tax purposes, but rather as property. As a result, upon the sale or exchange of virtual currency, taxpayers will recognize gain or loss based on the difference between the cash or the FMV of property received for the virtual currency and the taxpayer’s basis in the virtual currency exchanged (generally, the amount paid for the virtual currency). If the taxpayer holds the virtual currency as a capital asset (i.e., generally not as a dealer holding inventory or for sale to customers in a trade or business), that gain or loss would constitute capital gain or loss.

The 2014 Notice also established that if a taxpayer receives virtual currency as payment for goods or services, the taxpayer must include in gross income the FMV1 of the virtual currency (in US dollars) as of the date the virtual currency was received. In addition, if a taxpayer “mines” virtual currency, the taxpayer must include the FMV of that virtual currency in gross income on the date of receipt; if that taxpayer is an individual that is not acting in its capacity as an employee, then it would also be subject to self-employment tax. If an employee receives virtual currency in the form of wages, those wages are subject to withholding by their employer in the same manner as any other form of wages. Information reporting and backup withholding will generally apply to a payor of virtual currency in the same manner as any other payment.2

Treatment of “Hard Forks” and “Airdrops”

Revenue Procedure 2019-24 (the “2019 Procedure”) provides guidance specific to certain “cryptocurrency” transactions, including so-called “hard forks” and “airdrops.” The 2019 Procedure notes that cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a “distributed ledger” (e.g., a blockchain). A hard fork occurs when a distributed ledger undergoes a protocol change resulting in a permanent diversion from the existing distributed ledger. This may result in the creation of a brand new cryptocurrency that is recorded on a new distributed ledger, while the legacy cryptocurrency continues to be recorded on the legacy distributed ledger. A hard fork may be, but is not always, followed by an airdrop, whereby the new currency that was created is distributed to holders of the legacy cryptocurrency.

The 2019 Procedure provides that if a hard fork occurs without a corresponding airdrop of the new currency, then a taxpayer holding the legacy cryptocurrency will not include any amount in gross income as a result of the hard fork. If, however, a hard fork occurs and a taxpayer that holds legacy cryptocurrency receives an airdrop of the new cryptocurrency, then the taxpayer will be required to include as ordinary income the FMV of the new cryptocurrency as of the date and time it is received. However, if the taxpayer does not have “dominion and control” over the cryptocurrency received in the airdrop,3 then the taxpayer will not include the amount in gross income until such time as the taxpayer acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency. Going forward, the taxpayer’s basis in the airdropped new cryptocurrency will equal the amount of gross income recognized as a result of the airdrop.

Additional FAQs

In addition to the 2019 Procedure, the IRS updated the FAQs on its website with further information relevant to taxpayers transacting in cryptocurrency.4 The FAQs are generally consistent with those released in connection with the 2014 Notice and with the rules described in the 2019 Procedure, but they also include a few helpful additional clarifications.

Determining Fair Market Value

As described above, taxpayers will often be required to calculate the FMV of cryptocurrency in order to calculate the amount of gain or loss realized on a transaction. The FAQs provide that if cryptocurrency is received in a transaction facilitated by an exchange, the FMV of that cryptocurrency will equal the amount recorded by the exchange for that transaction in US dollars. If the transaction is facilitated by an exchange but is not recorded on a distributed ledger or is otherwise “off-chain,” then the FMV will be the amount for which the cryptocurrency was trading on the exchange at the date and time the transaction would have been recorded if it had been “on-chain.”

If cryptocurrency is received in a “peer-to-peer” transaction or otherwise in a transaction not facilitated by an exchange, the FMV will be determined on the date it is recorded on the ledger or the date it would have been recorded on the ledger if it had been an on-chain transaction. The IRS will accept as evidence for FMV the value determined by a cryptocurrency “explorer” that analyzes the worldwide indices of cryptocurrencies and calculates the value at an exact date and time. If the taxpayer does not use an explorer’s value, a taxpayer would have to establish an accurate FMV in some other manner.

If a taxpayer receives cryptocurrency in exchange for goods or services, but that cryptocurrency is not traded on any exchange and no published value is available, then the FMV of the cryptocurrency will equal the FMV of goods or services exchanged.

Soft Forks

The FAQs provide that if a cryptocurrency undergoes a “soft fork” (i.e., a protocol change in a distributed ledger that does not result in a diversion of the ledger or a new currency), then a taxpayer holding that cryptocurrency will not be required to recognize income.

Receipt of Cryptocurrency as a Gift

If a taxpayer receives virtual currency as a bona fide gift (i.e., the donor had the requisite intent to establish the gift was in fact a gift), then the taxpayer will not be required to recognize income until they sell, exchange, or otherwise dispose of the virtual currency.

For purposes of determining whether the recipient will recognize a gain on that subsequent disposition, the recipient’s basis will equal the donor’s basis plus any gift tax paid by the donor; for purposes of determining whether the taxpayer will recognize a loss, the recipient’s basis is equal to the lesser of the donor’s basis or the FMV of the virtual currency at the time the gift is received. If the recipient is unable to substantiate the donor’s basis, the recipient’s basis will be zero.

For purposes of determining whether any capital gain recognized is short-term or long-term, the recipient of the gift will include the donor’s holding period. If the recipient cannot substantiate the donor’s holding period, the recipient’s holding period will begin on the day after the gift is received.

Donation of Cryptocurrency

If a taxpayer donates cryptocurrency to a qualified charitable organization, no gain or loss will be recognized by the taxpayer upon the donation. The taxpayer will be entitled to receive a charitable contribution deduction in respect of the donated cryptocurrency equal to the FMV of the cryptocurrency if held for more than one year or the lesser of the taxpayer’s basis and the cryptocurrency’s FMV if held for one year or less.

Transfer Among Wallets

If a taxpayer transfers virtual currency from their own wallet, address, or other account to another wallet, address, or account also owned by that same taxpayer, then the transfer will not be taxable, even if an exchange sends the taxpayer an information return reflecting the transfer.

Identification of Units Upon a Sale

A taxpayer may acquire multiple units of the same cryptocurrency at different times and for different prices. A taxpayer may therefore have different tax bases and different holding periods for the various units they hold, resulting in different amounts of taxable income and different tax rates (i.e., long-term capital gain rates or ordinary income rates) when the units are sold depending on the particular units that are sold in the transaction. The FAQs provide that a taxpayer may choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if the taxpayer can identify those specific units involved in the transaction and substantiate its basis in those units. A specific unit of virtual currency can be identified using 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 held in a single account, wallet, or address.5

If the taxpayer does not identify a specific unit, the taxpayer will be deemed to have sold units on a “first in, first out” basis, meaning the taxpayer will be deemed to have first sold those units that the taxpayer acquired earliest in chronological order.

Additional Reporting Information

The FAQs also provide additional specificity as to the reporting requirements for virtual currency transactions. Consistent with other transactions generally, a participant in a virtual currency transaction is required to report income, gain, and loss on their tax return regardless of whether the taxpayer receives an information return.

Taxpayers that sell or engage in other transactions involving virtual currency held as a capital asset are required to report those transactions on Form 8949 (Sales and Other Dispositions of Capital Assets). Individuals must report their income from virtual currency on the applicable Form 1040 and the relevant Schedules.

Finally, the FAQs emphasize that taxpayers must maintain records regarding virtual currency transactions that are sufficient to establish the positions taken on their tax returns. This would include documentation regarding the receipt, sale, exchange, or other disposition of virtual currency and the FMV thereof.


Although many questions still remain, including whether cryptocurrency trading should be eligible for the US trade or business safe-harbor under Section 864(b)(2), the 2019 Procedure and the FAQs provide welcome guidance to taxpayers as the IRS begins to increase its scrutiny of virtual currency transactions. We will continue to monitor developments in this area and encourage you to reach out to the O’Melveny attorneys listed on this Client Alert regarding any questions or concerns you may have regarding virtual currency matters.

1 The 2014 Notice provides that if the virtual currency is listed on an exchange, the FMV can generally be determined by converting the virtual currency into US dollars (or into another currency that can be converted to US dollars) based on the exchange rate available on that exchange.

2 For example, if a person pays more than $600 of virtual currency to an independent contractor in the course of a trade or business, then the payor must report the payment on a Form 1099-MISC.

3 For example, if the new cryptocurrency is airdropped into a wallet managed by an exchange that does not support the new cryptocurrency such that the airdropped cryptocurrency is not immediately credited to the taxpayer’s account at the exchange.

4 See here.

5 The FAQs provide that this information must include (1) the date and time each unit was acquired, (2) your basis and the FMV of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the FMV of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Billy Abbott, an O’Melveny counsel licensed to practice law in California and New York, Alexander Anderson, an O’Melveny partner licensed to practice law in New York, Robert Fisher, an O’Melveny partner licensed to practice law in California, Luc Moritz, an O’Melveny partner licensed to practice law in California, and Eric Sibbitt, an O’Melveny partner licensed to practice law in California and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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