Bitcoin – the world’s first cryptocurrency – was invented in 2009, way back when the iPhone 3 was the hottest new tech toy on the block. However, just like the iPhone, Bitcoin needs an upgrade every so often. These upgrades (in theory) occur through hard forks in the Bitcoin blockchain. Hard forks create new versions of Bitcoin, like the increasingly popular Bitcoin Cash.
Bitcoin investors love forks because they’re viewed as money that’s basically free. If you held Bitcoin on a compatible exchange at the time a fork is released, you’re automatically entitled to claim the new coin created by the split. Basically, they work like a stock split – your ownership of the original blockchain currency entitles you to a payout once the blockchain is forked. As a result, Bitcoin Forks are often met with enthusiasm among the investment community.
Despite the initial appeal of Bitcoin forks, there are two well-known financial axioms that every investor should keep in mind. First, there ain’t no such thing as a free lunch. Second, the IRS always figures out how to get its dues.
Coin holders should understand how these splits will impact their tax return. When do they get reported and how do you establish the value of them?
While some people claim that you should report them at the time of receipt, this goes against every other method we use to analyze them. In stock spin-offs, we don’t count the new stock as income on the day or receipt.
Since the coin comes into being through a spin-off in the resources that maintain it (a fork in the software and the number of computers verifying those transactions and maintaining those ledgers) it makes more sense to treat it like a traditional stock spin-off. Especially with the existence of Bitcoin Cash and Bitcoin Gold were you may not even have receipt of it yet due to incompatibility with your exchange.
So what is the cost basis? That’s the key to this calculation. In a typical spin-off, the company issues guidance on how to allocate your cost basis. It is determined based on assets involved in the spin off. Since we are dealing with decentralized ecosystems, there is no central authority to issue this guidance. It is also nearly impossible to determine how much of the computing power has switched to the new coin. You could make guestimates but it complicates the process. The cleanest solution is simply to leave your original cost basis with the original coin and accept the new coin with a zero cost basis. It’s the most conservative approach and the easiest to consistently execute.
Each situation is unique though and needs to be evaluated as such. Finding a professional who understands the underlying structure of cryptocurrency helps them to make the best decisions on how to treat it for tax purposes.
Bitcoin investors can count on Happy Tax for the tax planning and preparation services they need to keep the IRS off their backs. The sale or swap of a new coin from a split on the Bitcoin blockchain is a taxable event, and the trained cryptocurrency accountants at Happy Tax can help you understand how they fit into your larger portfolio. By planning ahead, you can avoid a potentially costly misstep in handling your taxable cryptocurrency assets.