How Crypto Airdrops and Hard Forks Are Taxed
Learn about the IRS' guidance on how to pay tax on crypto airdrops and hard forks.
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Funds received from a hard fork or airdrop are taxed as ordinary income.
This income is reported at the value of the asset when it hit your wallet.
What is an airdrop?
Airdrops are free distributions of crypto to a large number of wallets. Usually, new platforms or blockchains airdrop tokens as rewards or incentives for users' support.
What is a hard fork?
A hard fork is a fundamental change in a blockchain that leads to two separate chains because nodes that meet consensus in the original mechanism do not reach consensus in the updated mechanism. This results in two diverging and separate systems.
The most famous hard fork is probably the one that separated Ethereum Classic from Ethereum, which was implemented in order to return funds to their owenrs after The DAO was hacked.
How are airdrops and hard forks taxed?
In 2019, the IRS released guidance that clarified how funds received from a hard fork or airdrop should be treated for tax purposes.
In answers 22 through 24 of the guidance, the IRS clarified that “if a hard fork is followed by an airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive that cryptocurrency.” This means that if you receive crypto in a hard fork or airdrop, you have to report it as income on your tax return.
The IRS further states that the income is equal to the fair market value of the crypto when you received and took full control of it. The cost basis is equal to the amount of income that you claimed.
Let's say you received 50 KLIMA from the KlimaDAO airdrop. If KLIMA was $2,000 when you received the airdrop, you would need to report $100,000 of income on your tax returns, regardless of the token's current price.
Controversy over how the IRS taxes airdrops
The IRS’s stance has not been without controversy.
Crypto holders don’t have a choice whether or not they want to accept a hard forked or airdropped coin. As a result, people who receive an asset they did not ask for may end up having to pay income tax on the asset.
What's more, these assets sometimes drop significantly in value after distribution, as many receivers sell the tokens. Remember that you will owe taxes on the asset's value when you received it, not on its current value or the value at which you disposed of it. This means, you may owe income taxes on an asset you are ultimately holding at a loss. Unfortunately, only $3,000 of income cannot be offset by capital losses.
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