In August of last year, Bitcoin Cash forked from the bitcoin blockchain. This process basically splits bitcoin into two separate coins: bitcoin (“BTC”) and Bitcoin Cash (“BCH”). When this occurred, everyone who held Bitcoin in a compatible wallet or exchange became entitled to claim an equivalent amount of Bitcoin Cash.
At the time of writing this article, a BCH coin would cost you around $1,000. Anyone who received the coin for free because they held BTC at the time of the fork is celebrating the coin’s success. Many investors may not even know that they are entitled to claim the coin since doing so often requires specific technical expertise. However, BCH can be claimed by any eligible investor at any time.
The success of Bitcoin Cash has been a windfall to many bitcoin investors. Now that tax season is upon us these investors must be sure to properly report their Bitcoin Cash to the IRS. In fact, Bitcoin holders need to understand how to report the receipt of any new currencies they receive as a result of recent and upcoming bitcoin forks. This is true even for forked coins that you have not yet redeemed.
Many people claim that you have to report the Bitcoin Cash as income at the time of receipt. But does that really understand the process by which it is generated and is there a better analogy in the IRS codes?
When the software that supports a coin forks, the resources that supported the coin ecosystem also fork. Since they can no longer solve bitcoin transaction problems and update ledgers, a new coin comes into existence. To encourage acceptance and recognize the resources that are pulled from the old coin to the new coin, a deposit is made available for anyone holding bitcoin (or other coins that fork) of the new coin.
A better analogy is that of a stock spin-off. Resources that formerly supported Bitcoin are now split to support Bitcoin Cash. Very similar to what happens when a company splits off a portion of their assets into a new company. You get stock in the new company in proportion to the stock you held in the old company. Typically the cost basis is allocated between the old and new stock. When the stock is sold a gain or loss is recognized.
Establishing the cost basis of the new coin can be difficult. Since we know the total cost basis of the new and old coin cannot exceed 100%, we have two choices to make.
Establish a complex formula to determine cost basis that varies with the time of receipt (since not everyone got the coin at the same time) and making it nearly impossible to track the cost basis of the original coin…. Or use the conservative approach of leaving 100% of the cost basis with the original coin and using a zero cost basis for the new coin. This method is the preferred one.
With many forks on the horizon for 2018, this can get complicated quickly. If you hold bitcoin, be sure to consult with a tax professional to make sure you understand how, what, and when you need to disclose information about forked coins to the IRS.
Even if you haven’t claimed a forked coin you’re entitled to a virtual currency split may be a taxable event in itself. By planning ahead, you can avoid a potentially costly misstep in handling your taxable cryptocurrency assets.