The Ultimate Guide To Taxation on Crypto Hard Forks.

by
Ravi Abhishek
Reviewed by
Brihasi Dey
min read
Last updated:

Forking in crypto occurs when blockchain networks undergo significant upgrades or changes which might lead to splitting of existing blockchain and creation of new cryptocurrency. 

While these events present exciting opportunities for the crypto community, they can significantly impact the tax landscape for investors and participants. 

As governments and regulatory bodies worldwide respond to the growing influence of digital assets, understanding the complexities of taxation on forked cryptocurrencies becomes paramount.

In this article, we provide all the details you need to know about crypto fork taxes to stay compliant.

What is a Crypto Fork?

Cryptocurrencies are decentralized meaning that the nodes or the participants on the network must agree unanimously and maintain the state of the blockchain. 

However, there are instances when network nodes fail to reach a unanimous consensus regarding the blockchain's future state. This gives rise to forks leading to chain splitting of the original blockchain into two or more valid chains.

Hard Fork

A hard fork represents a radical and non-backward compatible upgrade to a blockchain's protocol that leads to a split in the blockchain, creating two separate and distinct chains. 

These hard forks often arise due to disagreements within a community, where one group supports the new upgrades, and the other group does not. Nodes that do not upgrade continue to validate transactions based on the old rules, while nodes on the updated version adhere to the new set of rules. 

A notable example of this is the Bitcoin and Bitcoin Cash hard fork. In 2017, a proposal was made to increase the block size of the Bitcoin blockchain, aiming to enhance transaction speed and data storage capabilities in a single block. This proposal sparked a significant disagreement within the Bitcoin community, leading to a hard fork.

Soft Fork

In contrast, a soft fork is like a software upgrade that introduces backward-compatible changes to the blockchain's protocol. The new rules are designed to coexist harmoniously with the existing ones, allowing nodes with the older version to perceive the new version as valid. 

Unlike hard forks, soft forks do not create new cryptocurrencies. Instead, they introduce upgrades that enhance the blockchain's efficiency or security. An example of a soft fork is the Segregated Witness (SegWit) upgrade on the Bitcoin blockchain.

Impact of hard forks on cryptocurrency holders

Hard forks can have various implications for cryptocurrency holders. Holders of the original cryptocurrency at the time of the fork usually receive an equal amount of the new cryptocurrency. This means that they effectively hold both the original cryptocurrency and the newly created one.

On the other hand, since a soft fork is simply a software upgrade and doesn't lead to the creation of a new cryptocurrency, it doesn't grant additional tokens to holders. Instead, all existing tokens remain unaffected and continue to be valid on the upgraded network.

The impact of a hard fork on the value of cryptocurrencies can be unpredictable. Hard forks result in the new cryptocurrency gaining significant value and market support, while others may not gain much traction.

Additionally, the existence of multiple blockchains can lead to fragmentation within the community, with supporters of the original and new chains advocating for different visions and principles. This can result in debates, market volatility, and uncertainty surrounding the long-term viability of each cryptocurrency.

Taxation on Cryptocurrency Forks

The taxation of crypto forks in the world of cryptocurrencies varies depending on the type of fork and how tax authorities classify digital assets. Since in most countries, cryptocurrencies are considered assets, taxes are applicable when you dispose of them. 

There are mainly two types of taxes involved in the case of crypto hard forks: Capital gains tax and Income tax. 

Engaging in activities such as trading, selling, gifting, exchanging cryptocurrencies, converting them to fiat currency, or using them for goods and services qualifies as a capital gains event. 

Additionally, any earnings received from cryptocurrencies, like airdrops or staking rewards, must be declared as "income" on your tax return.

Soft forks typically do not trigger any tax implications because they do not create new coins or tokens in your wallet.

IRS Guidelines on Crypto Hard Fork Taxes

According to the IRS, any new coins acquired through a hard fork should be considered taxable income and are subject to Income Tax. 

When you receive cryptocurrency as part of an airdrop following a hard fork, the IRS considers it as ordinary income. The amount of income is equal to the fair market value of the new cryptocurrency at the time of receipt, which is when the transaction is recorded on the distributed ledger. 

However, to be eligible for taxation, you must have full control over the cryptocurrency, allowing you to transfer, sell, exchange, or dispose of it in any way you choose. Properly reporting and accounting for such income is essential to comply with tax regulations and ensure accurate tax filings.

This income should be reported under the category of "other income" on your IRS Form 1040.

In addition to Income Tax, if you decide to sell, swap, or use the forked assets for transactions, any resulting profit will be subject to Capital Gains Tax. You will need to report these capital gains on your IRS Form 8949.

Tax Reporting and Compliance

Follow these tips to ensure that you stay compliant with the tax guidelines:

Keeping Accurate Records of Cryptocurrency Transactions

Keeping thorough and organized records of cryptocurrency transactions is essential for tax reporting and compliance. 

These records should include details such as dates, transaction amounts, the fair market value of tokens at the time of receipt or disposal, and any associated costs or fees.

Utilizing digital wallets, exchanges, or specialized cryptocurrency tax software can help individuals, businesses, and investors maintain accurate records and track their cryptocurrency activities effectively.

Utilizing Cryptocurrency Tax Software or Professional Assistance

As the complexity of cryptocurrency tax regulations continues to evolve, individuals and businesses may find it beneficial to leverage specialized cryptocurrency tax software or seek professional assistance from tax professionals with expertise in digital currencies. 

These tools and professionals can provide guidance, ensure accurate tax calculations, and assist with proper reporting and compliance.

Reporting Requirements to Tax Authorities

Depending on the jurisdiction, individuals, businesses, and investors may be required to report their cryptocurrency activities to tax authorities. 

This typically involves including relevant information, such as capital gains or losses from the sale or exchange of hard-forked tokens, in annual tax returns or separate cryptocurrency-related forms.

It is essential to stay informed about the specific reporting requirements of the jurisdiction in which you reside or operate to avoid penalties or legal consequences.

Calculate Crypto Taxes With Kryptos

A powerful crypto tax software can make your life as an investor a lot easier – from managing all your assets in one place to finding its tax implications and maximizing savings. 

The easiest way to start is to use Kryptos, a powerful app designed to simplify the entire crypto tax process for investors. Its intuitive interface, robust analytics, and wide range of integrations make it an ideal choice for both active and passive investors. 

All you have to do is add your wallet or exchange to the app, and it auto-syncs real-time data of all your assets for you. 

You can easily manage your portfolio including NFTs and DeFi from their dashboard and calculate your capital gains, claim losses, and know your tax liability. 

To get started, Sign Up Now.

FAQs

1. Are all hard-forked tokens taxable?

Not all hard-forked tokens are necessarily taxable. The tax treatment depends on various factors, including the jurisdiction's tax regulations, the individual's specific circumstances, and the intention behind holding the tokens. It is important to consult with a tax professional to determine the tax implications of a particular hard fork.

2. What if I received hard-forked tokens but never sold them?

The mere possession of hard-forked tokens may still trigger taxable events in certain jurisdictions. Even if you haven't sold or traded the tokens, you might need to report them as taxable income or capital gains based on the fair market value at the time of the fork. Consult with a tax professional to understand your specific tax obligations.

3. Can I use cryptocurrency tax software to handle hard fork tax reporting?

Yes, cryptocurrency tax software can assist in calculating and reporting tax obligations related to hard-forked tokens. However, it is important to ensure that the software you choose supports hard fork tax reporting and integrates the necessary features for accurate valuation and compliance.

4. What are the potential penalties for non-compliance with cryptocurrency tax obligations?

Penalties for non-compliance with cryptocurrency tax obligations can vary depending on the jurisdiction and the severity of the violation. They can include fines, interest charges, and in some cases, criminal prosecution. It is crucial to meet your tax obligations and seek professional guidance to avoid potential penalties.

5. Is it possible to amend past tax returns to include hard fork transactions?

If you failed to report hard fork transactions in previous tax returns, it is generally possible to file an amendment to correct the omission. Consult with a tax professional to understand the process and requirements for amending past tax returns.

All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!

Arrow

The Ultimate Guide To Taxation on Crypto Hard Forks.

By
Ravi Abhishek
On

Forking in crypto occurs when blockchain networks undergo significant upgrades or changes which might lead to splitting of existing blockchain and creation of new cryptocurrency. 

While these events present exciting opportunities for the crypto community, they can significantly impact the tax landscape for investors and participants. 

As governments and regulatory bodies worldwide respond to the growing influence of digital assets, understanding the complexities of taxation on forked cryptocurrencies becomes paramount.

In this article, we provide all the details you need to know about crypto fork taxes to stay compliant.

What is a Crypto Fork?

Cryptocurrencies are decentralized meaning that the nodes or the participants on the network must agree unanimously and maintain the state of the blockchain. 

However, there are instances when network nodes fail to reach a unanimous consensus regarding the blockchain's future state. This gives rise to forks leading to chain splitting of the original blockchain into two or more valid chains.

Hard Fork

A hard fork represents a radical and non-backward compatible upgrade to a blockchain's protocol that leads to a split in the blockchain, creating two separate and distinct chains. 

These hard forks often arise due to disagreements within a community, where one group supports the new upgrades, and the other group does not. Nodes that do not upgrade continue to validate transactions based on the old rules, while nodes on the updated version adhere to the new set of rules. 

A notable example of this is the Bitcoin and Bitcoin Cash hard fork. In 2017, a proposal was made to increase the block size of the Bitcoin blockchain, aiming to enhance transaction speed and data storage capabilities in a single block. This proposal sparked a significant disagreement within the Bitcoin community, leading to a hard fork.

Soft Fork

In contrast, a soft fork is like a software upgrade that introduces backward-compatible changes to the blockchain's protocol. The new rules are designed to coexist harmoniously with the existing ones, allowing nodes with the older version to perceive the new version as valid. 

Unlike hard forks, soft forks do not create new cryptocurrencies. Instead, they introduce upgrades that enhance the blockchain's efficiency or security. An example of a soft fork is the Segregated Witness (SegWit) upgrade on the Bitcoin blockchain.

Impact of hard forks on cryptocurrency holders

Hard forks can have various implications for cryptocurrency holders. Holders of the original cryptocurrency at the time of the fork usually receive an equal amount of the new cryptocurrency. This means that they effectively hold both the original cryptocurrency and the newly created one.

On the other hand, since a soft fork is simply a software upgrade and doesn't lead to the creation of a new cryptocurrency, it doesn't grant additional tokens to holders. Instead, all existing tokens remain unaffected and continue to be valid on the upgraded network.

The impact of a hard fork on the value of cryptocurrencies can be unpredictable. Hard forks result in the new cryptocurrency gaining significant value and market support, while others may not gain much traction.

Additionally, the existence of multiple blockchains can lead to fragmentation within the community, with supporters of the original and new chains advocating for different visions and principles. This can result in debates, market volatility, and uncertainty surrounding the long-term viability of each cryptocurrency.

Taxation on Cryptocurrency Forks

The taxation of crypto forks in the world of cryptocurrencies varies depending on the type of fork and how tax authorities classify digital assets. Since in most countries, cryptocurrencies are considered assets, taxes are applicable when you dispose of them. 

There are mainly two types of taxes involved in the case of crypto hard forks: Capital gains tax and Income tax. 

Engaging in activities such as trading, selling, gifting, exchanging cryptocurrencies, converting them to fiat currency, or using them for goods and services qualifies as a capital gains event. 

Additionally, any earnings received from cryptocurrencies, like airdrops or staking rewards, must be declared as "income" on your tax return.

Soft forks typically do not trigger any tax implications because they do not create new coins or tokens in your wallet.

IRS Guidelines on Crypto Hard Fork Taxes

According to the IRS, any new coins acquired through a hard fork should be considered taxable income and are subject to Income Tax. 

When you receive cryptocurrency as part of an airdrop following a hard fork, the IRS considers it as ordinary income. The amount of income is equal to the fair market value of the new cryptocurrency at the time of receipt, which is when the transaction is recorded on the distributed ledger. 

However, to be eligible for taxation, you must have full control over the cryptocurrency, allowing you to transfer, sell, exchange, or dispose of it in any way you choose. Properly reporting and accounting for such income is essential to comply with tax regulations and ensure accurate tax filings.

This income should be reported under the category of "other income" on your IRS Form 1040.

In addition to Income Tax, if you decide to sell, swap, or use the forked assets for transactions, any resulting profit will be subject to Capital Gains Tax. You will need to report these capital gains on your IRS Form 8949.

Tax Reporting and Compliance

Follow these tips to ensure that you stay compliant with the tax guidelines:

Keeping Accurate Records of Cryptocurrency Transactions

Keeping thorough and organized records of cryptocurrency transactions is essential for tax reporting and compliance. 

These records should include details such as dates, transaction amounts, the fair market value of tokens at the time of receipt or disposal, and any associated costs or fees.

Utilizing digital wallets, exchanges, or specialized cryptocurrency tax software can help individuals, businesses, and investors maintain accurate records and track their cryptocurrency activities effectively.

Utilizing Cryptocurrency Tax Software or Professional Assistance

As the complexity of cryptocurrency tax regulations continues to evolve, individuals and businesses may find it beneficial to leverage specialized cryptocurrency tax software or seek professional assistance from tax professionals with expertise in digital currencies. 

These tools and professionals can provide guidance, ensure accurate tax calculations, and assist with proper reporting and compliance.

Reporting Requirements to Tax Authorities

Depending on the jurisdiction, individuals, businesses, and investors may be required to report their cryptocurrency activities to tax authorities. 

This typically involves including relevant information, such as capital gains or losses from the sale or exchange of hard-forked tokens, in annual tax returns or separate cryptocurrency-related forms.

It is essential to stay informed about the specific reporting requirements of the jurisdiction in which you reside or operate to avoid penalties or legal consequences.

Calculate Crypto Taxes With Kryptos

A powerful crypto tax software can make your life as an investor a lot easier – from managing all your assets in one place to finding its tax implications and maximizing savings. 

The easiest way to start is to use Kryptos, a powerful app designed to simplify the entire crypto tax process for investors. Its intuitive interface, robust analytics, and wide range of integrations make it an ideal choice for both active and passive investors. 

All you have to do is add your wallet or exchange to the app, and it auto-syncs real-time data of all your assets for you. 

You can easily manage your portfolio including NFTs and DeFi from their dashboard and calculate your capital gains, claim losses, and know your tax liability. 

To get started, Sign Up Now.

FAQs

1. Are all hard-forked tokens taxable?

Not all hard-forked tokens are necessarily taxable. The tax treatment depends on various factors, including the jurisdiction's tax regulations, the individual's specific circumstances, and the intention behind holding the tokens. It is important to consult with a tax professional to determine the tax implications of a particular hard fork.

2. What if I received hard-forked tokens but never sold them?

The mere possession of hard-forked tokens may still trigger taxable events in certain jurisdictions. Even if you haven't sold or traded the tokens, you might need to report them as taxable income or capital gains based on the fair market value at the time of the fork. Consult with a tax professional to understand your specific tax obligations.

3. Can I use cryptocurrency tax software to handle hard fork tax reporting?

Yes, cryptocurrency tax software can assist in calculating and reporting tax obligations related to hard-forked tokens. However, it is important to ensure that the software you choose supports hard fork tax reporting and integrates the necessary features for accurate valuation and compliance.

4. What are the potential penalties for non-compliance with cryptocurrency tax obligations?

Penalties for non-compliance with cryptocurrency tax obligations can vary depending on the jurisdiction and the severity of the violation. They can include fines, interest charges, and in some cases, criminal prosecution. It is crucial to meet your tax obligations and seek professional guidance to avoid potential penalties.

5. Is it possible to amend past tax returns to include hard fork transactions?

If you failed to report hard fork transactions in previous tax returns, it is generally possible to file an amendment to correct the omission. Consult with a tax professional to understand the process and requirements for amending past tax returns.

All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!

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