Checkbox for virtual currency
IRS requires disclosure of virtual currency transactions with the virtual currency checkbox on Form 1040 and provides guidance on hard forks and air drops of virtual currency.
Virtual currency is considered property for federal income tax purposes. Transactions involving virtual currency are often similar to transactions involving stock investments, although virtual currency is not a stock.
The IRS published initial guidance on virtual currency in 2014 and further guidance was released in 2019, including rules for hard forks, airdrops, and how to deal with the virtual currency checkbox.
Virtual currency checkbox
The virtual currency checkbox includes the following question: “At any time during [the tax year], did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The instructions require the taxpayer to check “yes” if any of the following transactions occurred:
- The receipt or transfer of virtual currency for free (including from an airdrop or hard fork).
- An exchange of virtual currency for goods or services.
- A sale of virtual currency.
- An exchange of virtual currency for other property, including another type of virtual currency.
- A disposition of a financial interest in virtual currency.
For 2019, the question was at the top of Schedule 1 (Form 1040). Taxpayers who have not engaged in any virtual currency transactions check “No” if they’re filing Schedule 1 for some other reason. In other words, taxpayers do not have to file Schedule 1 solely to check the box “No” if they did not have any transactions.
In 2020, the virtual currency checkbox was moved to the first page of Form 1040. The 1040 instructions provide additional guidance about virtual currency transactions. The IRS said the following do not count as virtual currency transactions:
- Transferring virtual currency between two accounts or digital wallets when both are owned or controlled by the same taxpayer, or
- Holding a virtual currency in a digital wallet or account.
Taxpayers are advised to report virtual currency transactions as they would record other activity of the same type. For example, the sale of virtual currency held as a capital asset is reported on Form 8949 and Schedule D. The payment of virtual currency to acquire inventory used in a trade or business is recorded on Schedule C for a sole proprietorship.
Hard forks and airdrops
News release IR-2019-167 and Rev. Rul. 2019-24 explain the tax consequences of new cryptocurrency received following a hard fork. Cryptocurrency, such as Bitcoin, is a type of virtual currency that utilizes cryptography to digitally record transactions on a distributed ledger, such as blockchain.
A “hard fork” occurs when a distributed ledger undergoes a “protocol change” that results in a permanent diversion from an existing or “legacy” ledger. The result is that a new cryptocurrency may be created on a new distributed ledger that is separate from the legacy cryptocurrency and the legacy distributed ledger. After the hard fork, transactions involving the new and legacy cryptocurrencies are recorded on their respective distributed ledgers.
A hard fork may or may not result in an “airdrop” of the new cryptocurrency to the addresses existing in the legacy distributed ledger. A taxpayer is in receipt of the new cryptocurrency if the taxpayer is able to exercise dominion and control over the new cryptocurrency. That is, the newly created cryptocurrency is credited to the taxpayer’s account or “wallet” at the cryptocurrency exchange and the taxpayer is able to transfer, sell, exchange, or otherwise dispose of the new cryptocurrency.
A taxpayer who receives and has dominion and control over units of a new cryptocurrency as the result of a hard fork recognizes ordinary income based on the fair market value of the units received.
Example: Bella holds 50 units of “Crypto R.” On December 4, Crypto R experiences a hard fork and creates “Crypto S.” On that date, 25 units of Crypto S are airdropped to Bella’s distributed ledger address. Crypto S is valued at $50 per unit at the time of the airdrop. Bella could immediately dispose of the new cryptocurrency. Transactions involving the existing and new cryptocurrencies are recorded on their respective distributive ledgers. On her tax return, Bella must recognize ordinary income of $1,250 (25 units of Crypto S × $50). Had she not received units of the new cryptocurrency, or if she did not have dominion and control over them, she would not be required to recognize income. Bella’s basis in Crypto S is also $1,250, the amount of income recognized.
Other virtual currency checkbox information
The IRS has also provided an extensive Frequently Asked Questions on Virtual Currency Transactions. The FAQ covers most aspects of acquiring, holding, exchanging, and selling virtual currencies.
For more information on cryptocurrency and how its reported, see the Insights article, “Cryptocurrency: Secret currency or taxable property?”