In CCA 202114020[1] the IRS outlines the impact of two different situations involving 2017’s hard fork of Bitcoin that created Bitcoin Cash and allocated one unit of Bitcoin Cash for each unit of Bitcoin held by a taxpayer.

Analysis of Prior IRS Guidance on Hard Forks

The guidance begins by noting the facts related to the hard fork that created Bitcoin Cash:

On August 1, 2017, at 9:16 a.m., EDT (13:16, UTC), block 478,558 on the Bitcoin block chain was mined. This was the last common block shared by both the Bitcoin and Bitcoin Cash distributed ledgers. Immediately following the mining of block 478,558, Bitcoin miners began mining a block that continued to follow Bitcoin’s protocols but was incompatible with Bitcoin Cash’s protocols. At the same time, Bitcoin Cash miners began mining a block that followed the Bitcoin Cash protocol but was no longer compatible with Bitcoin’s protocols. Beginning at this date and time, holders of Bitcoin Cash were, in general, able to engage in Bitcoin Cash transactions that would not be reflected in the Bitcoin distributed ledger and would have no effect on their Bitcoin holdings.[2]

The IRS, in a footnote to the ruling, points out that some individuals holding Bitcoin in major exchanges did not have immediate access to the Bitcoin Cash:

Some taxpayers holding Bitcoin through hosted wallets at cryptocurrency exchanges did not have dominion and control of the new Bitcoin Cash at the time of the hard fork. For example, the cryptocurrency exchange, Coinbase, began supporting Bitcoin Cash on December 19, 2017. Prior to that date Coinbase’s customers were unable to buy, sell, receive, transfer, or exchange Bitcoin Cash through their Coinbase accounts. See Buy, sell, send and receive Bitcoin Cash on Coinbase, COINBASE (Dec. 20, 2017), available at https://blog.coinbase.com/buy-sell-send-and-receive-bitcoin-cash-on-coinbase-65f1b2c7214b.[3]

This memorandum looks at the issue of what impact, if any, does such delayed access in the case of a hard fork have on the taxpayer’s recognition of income from the hard fork.

The IRS begins an analysis of the tax impact of this situation by applying the general income rules applicable to IRC §61(a)(3) to a hard fork:

Section 61(a)(3) provides that, except as otherwise provided by law, gross income means all income from whatever source derived, including gains from dealings in property. Under § 61, all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion, are included in gross income. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). A taxpayer owning a cryptocurrency that undergoes a hard fork has received gross income under § 61 if the hard fork results in a new cryptocurrency and the taxpayer actually or constructively receives the new cryptocurrency as a result of the hard fork. I.R.C. § 61; Treas. Reg. § 1.451-2; Rev. Rul. 2019-24.[4]

The discussion goes on next to discuss Revenue Ruling 2019-24 that applied this principal directly to a hard fork:

Revenue Ruling 2019-24 applies the general principles of § 61 to conclude that the receipt of a new cryptocurrency following a hard fork results in income. Specifically, the ruling includes in the facts an airdrop following a hard fork as an example of how a taxpayer could receive new cryptocurrency from a hard fork. The specific means by which the new cryptocurrency is distributed or otherwise made available to a taxpayer following a hard fork does not affect the Revenue Ruling’s holding.[5]

Taxpayer Who Had Personal Control Over Bitcoin Private Key at Time of Hard Fork

The first situation the IRS looks at involves a case where the taxpayer had control over the private key to the distributed ledger address for 1 unit of Bitcoin:

Situation 1

A had sole control over the private key to a distributed ledger address that, as of August 1, 2017, at 9:16 a.m., EDT, held 1 unit of Bitcoin. Following the hard fork, A’s distributed ledger address continued to hold 1 unit of Bitcoin while also holding 1 unit of Bitcoin Cash. At that time, A had the ability to initiate a transaction to dispose of some or all of A’s Bitcoin Cash holdings.[6]

In that situation, the CCA comes to the conclusion that the taxpayer must immediately recognize income by looking at the fair market value of the new virtual currency received:

A received 1 unit of Bitcoin Cash at the time of the hard fork and had dominion and control over that unit as evidenced by A’s ability to sell, exchange, or transfer the Bitcoin Cash. A has ordinary income in the 2017 taxable year equal to the fair market value of the Bitcoin Cash as of August 1, 2017, at 9:16 a.m., EDT. A can determine the Bitcoin Cash’s fair market value using any reasonable method, such as adopting the publicly published price value at a cryptocurrency exchange or cryptocurrency data aggregator.[7]

Taxpayer Had Bitcoin on an Exchange That Did Not Immediately Provide Access to Bitcoin Cash

In the second situation, the taxpayer has the Bitcoin on deposit in an exchange at the time of the hard fork:

Situation 2

B is a customer of CEX, a cryptocurrency exchange that provides hosted wallet services. As of August 1, 2017, at 9:16 a.m., EDT, B owned 1 unit of Bitcoin, which was held by CEX in a hosted wallet. CEX had sole control over the private key to a distributed ledger address that, as of August 1, 2017, at 9:16 a.m., EDT, held 100 units of Bitcoin. According to CEX’s off-chain, internal ledger, one unit of the 100 units of Bitcoin was owned by B.

After the hard fork, CEX’s distributed ledger address continued to hold 100 units of Bitcoin while also holding 100 units of Bitcoin Cash. CEX, however, was uncertain of Bitcoin Cash’s security and long-term viability and chose not to support Bitcoin Cash at the time of the hard fork. As a result, B was unable to buy, sell, send, receive, transfer, or exchange any Bitcoin Cash through B’s account with CEX, and CEX did not update its internal ledger to reflect that B owned any Bitcoin Cash. On January 1, 2018, at 1:00 p.m., EDT, CEX initiated support for Bitcoin Cash, allowing B to buy, sell, send, receive, transfer, or exchange Bitcoin Cash, including part or all of the 1 unit in B’s account.[8]

In this case, the IRS finds the taxpayer did not have taxable income immediately upon the hard fork, but rather only later when granted access to the Bitcoin Cash:

B did not have dominion and control over any Bitcoin Cash at the time of the hard fork, and therefore did not receive any income from the hard fork at that time. On January 1, 2018, at 1:00 p.m., EDT, CEX initiated support of Bitcoin Cash, allowing B — for the first time — to sell, transfer, or exchange B’s 1 unit of Bitcoin Cash. B has ordinary income in the 2018 taxable year equal to the fair market value of the Bitcoin Cash as of January 1, 2018, at 1:00 p.m., EDT. B can determine the fair market value by consulting CEX’s pricing data. If CEX lacks such information, B can use any other reasonable method.[9]

[1] CCA 202114020, April 9, 2021, https://www.irs.gov/pub/irs-wd/202114020.pdf (retrieved April 9, 2021)

[2] CCA 202114020, BACKGROUND, April 9, 2021

[3] CCA 202114020, FOOTNOTES, Footnote 1, April 9, 2021

[4] CCA 202114020, DISCUSSION, April 9, 2021

[5] CCA 202114020, DISCUSSION, April 9, 2021

[6] CCA 202114020, FACTS, April 9, 2021

[7] CCA 202114020, DISCUSSION, April 9, 2021

[8] CCA 202114020, FACTS, April 9, 2021

[9] CCA 202114020, DISCUSSION, April 9, 2021