In 2019, the IRS issued IRS Rev. Rul. 2019-24 to establish tax implications for when digital currency investors participate in an “airdrop” of new digital currency derived from a “hard fork.” Below is a direct excerpt from the ruling:
(1) A taxpayer does not have gross income under § 61 as a result of a hard fork of a cryptocurrency the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency.
(2) A taxpayer has gross income, ordinary in character, under § 61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency.
If you participate in digital currency investments with a Self-Directed IRA, you may be thinking that your tax advantaged account will shelter your investment returns from any tax consequences. Unfortunately, this is not an insulated event for an IRA account, and here’s why.
What is a hard fork and an airdrop?
If you are not familiar with the terminology, a hard fork is when there is a permanent split in an original blockchain to create a new digital currency on a new block chain. A widely publicized example that you can refer to is when Bitcoin hard forked to create Bitcoin Cash in 2017. There have been various others since then, but none with as much success as Bitcoin Cash.
An airdrop is the delivery of the new digital currency from the hard fork to holders of the original digital currency, typically in equivalent volume to their current holdings. To participate in the airdrop, the digital currency holders must be able to show proof of their current holdings.
What does the IRS Ruling mean?
IRS Rev. Rul. 2019-24 has determined that, in the event of a hard fork, if a digital currency holder participates in an airdrop to receive the new digital currency, the new currency is treated as ordinary gross income which makes this activity a taxable event. If the digital currency holder chooses not to participate in an airdrop in the event of a hard fork, then there are no tax consequences. This income classification is extremely important to understanding the tax implications for an IRA that chooses to participate in this type of investment activity.
What are the tax implications for an IRA?
If you read our blog, “Hidden Taxes in an IRA: UBIT Uncovered”, you would know that, per IRS regulations, a retirement account that receives what is determined to be ordinary income, NOT passive income, then those earnings will be subject to Unrelated Business Income Tax (UBIT). Depending on the amount of income earned, it could be subject to up to 37% in UBIT related taxes. If UBIT applies, the IRA account holder is solely responsible for filing the IRS 990-T tax form.
Can a Preferred Trust Company client participate in a hard fork airdrop?
As a licensed custodian, Preferred Trust Company reserves the right to facilitate or not facilitate certain investment activities in order to preserve the highest standard of compliance in the custody of IRA assets. For this reason, Preferred Trust Company (as have many other custodians), will not facilitate this investment activity within a client’s IRA.
Is there another option for clients that still wish to participate in a hard fork airdrop with assets from their IRA?
There is a method that clients can use to participate in a hard fork airdrop to avoid subjecting their IRA to UBIT. However, we strongly encourage clients to perform their due diligence on the method and the platforms that they choose to perform the airdrop. Depending on the platform, you could be required to provide the private key to the digital currency for the platform to verify the number of units of the original currency currently held in order to receive the new digital currency.
Below is a general description of the process:
Step 1: Contact Preferred Trust Company at 888.990.7892 so that we can verify the specifics of this process as it pertains to the individual client’s IRA assets.
Step 2: The client fills out the IRA Distribution Form to direct Preferred Trust Company to distribute the digital assets to their own established wallet.
Step 3: Once the assets have been distributed to the wallet, the client must perform the airdrop and return the exact number of units distributed back to the IRA within 60 days. Failure to do so could potentially incur tax consequences and penalties depending on the type of IRA account and the age of the account owner.
Step 4: Once complete, a written notice via email for the transfer of digital assets back to the account is required.
Preferred Trust Company continues to provide custodial services and educational information with the best interest of our clients in mind. As a reminder, licensed custodians are not legally allowed to provide investment advice nor legal/tax advice to clients. It is the sole responsibility of the IRA account owner to keep appraised of the regulatory impacts regarding their investment assets and activities, and to seek legal/tax advice from a professional at their own discretion.
