In light of the Aug. 1 split of Bitcoin into two separate cryptocurrencies, Bitcoin and Bitcoin Cash, many questions remain. While the IRS has issued guidance on cryptocurrency — labeling it an “intangible asset” for investors subject to capital gains and loss treatment using the realization method — it has not issued guidance on cryptocurrency split or “fork” transactions. There are thousands of cryptocurrencies, and many formed in this type of division in the blockchain.
Tax reporting for the receipt of Bitcoin Cash
The initial market price of Bitcoin Cash was $266 per unit, which was 9.5% of the comparable Bitcoin unit price at that time of $2,801. Bitcoin holders were distributed one unit of Bitcoin Cash for each unit of Bitcoin, a separate financial instrument with a liquid market value. In the eyes of the IRS, that’s taxable income. (An alternative name for Bitcoin Cash is BCash.)
Bitcoin holders should report the receipt of Bitcoin Cash on their 2017 income tax returns. It does not qualify as dividend income on Schedule B since a cryptocurrency is not a security. It’s also not considered interest income on a debt instrument or bank deposit. I suggest reporting the value received as “Other Income” on line 21 of Form 1040 —a catchall category for income that does not fit into a standard category.
Some taxpayers might choose to use Form 8949 (Sales and Other Dispositions of Capital Assets) instead. The taxpayer reports the $266 value of Bitcoin Cash as proceeds and 9.5% of Bitcoin cost basis as Bitcoin Cash cost basis. The initial value of Bitcoin Cash was 9.5% of the Bitcoin price at that time. This alternative treatment reduces taxable income by the cost basis amount. Another benefit is capital gains use up capital loss carryovers. I question whether this method would pass muster with the IRS — Bitcoin did not decline in value by a material amount after the split, and that undermines the use of this treatment.
Constructive receipt of income
Some Bitcoin holders mishandled or skipped arranging access to Bitcoin Cash, or their exchange does not support Bitcoin Cash, making retrieval difficult or impossible after Aug. 1, 2017. These taxpayers may believe they don’t have to report the Bitcoin Cash as taxable income since they don’t currently have access to it. While that seems reasonable, the IRS could apply the constructive receipt of income doctrine to argue the Bitcoin holder had access to Bitcoin Cash but turned his or her back on receiving it. Kelly Phillips Erb of Forbes goes into more detail in her article, Bitcoin Shift Could Cause Tax Headaches For Some Users).
Tax reporting for the sale of Bitcoin Cash
If you sold your Bitcoin Cash, you need to use capital gains treatment on Form 8949. For proceeds, enter the selling price. For cost basis, enter the $266 Bitcoin Cash value received per unit as you previously reported it as Other Income on line 21 of your 2017 Form 1040. The holding period for these units of Bitcoin Cash started on Aug. 1, 2017.
A cryptocurrency split is not a tax-free exchange
Taxpayers may feel a cryptocurrency split such as Bitcoin Cash qualifies as a tax-free exchange. I don’t think it does because cryptocurrencies are not securities, where tax-free splits are possible.
“Receipt of new Bitcoin Cash assets is a taxable event,” said tax attorney Roger D. Lorence. “Corporate taxation concepts on distributions to shareholders, dividends, spinoffs, split-offs, corporate reorganization nonrecognition events under Section 368 and allied rules, are all not applicable, as cryptocurrency is not a security. The new Bitcoin Cash assets are substantially different economically from the old Bitcoin assets.”
Lorence said the Supreme Court decision in Cottage Savings supports the view that the two classes of Bitcoin assets are not identical and therefore the transfer of the assets is considered a new class for which no nonrecognition provision of the code applies.
The IRS goes after cryptocurrency investors
Many cryptocurrency investors made a fortune the past several years selling high-flying Bitcoin and other cryptocurrencies for cash. Unfortunately, far too many of them did not report this taxable income to the IRS. Some cryptocurrency investors used Section 1031 like-kind exchange tax law to defer taxation, but that may be inappropriate (stay tuned for a blog post on that soon). Some cryptocurrency exchanges issued Form 1099-K, Payment Card and Third Party Network Transactions. The IRS feels they are insufficiently informed, so they are taking action.
Bitcoin rose in price from $13 in 2009 to more than $3,000 on June 11, 2017, and on Aug. 1, 2017, its market cap was $44 billion. Ethereum had a market cap of $21 billion. Bitcoin Cash skyrocketed overnight to a market cap of $12 billion on Aug. 2, 2017. The IRS figures hundreds of thousands of American residents did not report income from sales or exchanges of cryptocurrency and they might be able to collect several billion dollars in back taxes, penalties, and interest.
The IRS recently summoned Coinbase, one of the largest cryptocurrency exchanges, to turn over its customer lists. It later agreed to narrow the scope of the list to people with cryptocurrency transactions worth over $20,000 without a Form 1099-K. (Read IRS Blinks in Bitcoin Probe, Exempts Coinbase Transactions Under $20,000.)
Tax treatment for sales of cryptocurrencies
The IRS was slow to issue guidance for cryptocurrencies. It finally declared cryptocurrencies an “intangible asset,” not a sovereign currency, and sales and exchanges are subject to capital gain or loss treatment for investors and traders, using the realization method. (Read If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)
There is tax controversy brewing with cryptocurrency investors, which means tax exams will escalate. Don’t be greedy: Pay your capital gains taxes on windfall income and amend tax returns to report capital gains before the IRS catches up with you.
Darren Neuschwander CPA, Adam Manning CPA and tax attorneys Roger D. Lorence and Mark M. Feldman contributed to this blog post.