UPDATE: While the below article is still relevant, the income recognition principles discussed are only one of many ways to analyze the treatment of hard-fork income. For example, hard-fork income can also be analogized to a stock split. Upon the hard-fork (i.e. split), the new currency could then be allocated all, some, or none of the basis from the original currency. Upon the BCH hard-fork, an argument could be made that the basis of the entire currency remains in the BTC, with a BCH cost basis of $0. Thus, upon disposition of the BCH, a taxpayer would realize gain on the entire sales price. Should the taxpayer hold on to the BCH, not sell it, or its value shrink to $0, then there would be no tax consequence. Again, while the below article is still relevant and may in fact be the "uber technical" analysis of how to treat hard-fork income, there are other approaches such as the above stock-split analogy. To be clear however, the IRS has not yet provided their official position on the issue.
Tax Considerations Surrounding Coinbase’s BCH Wallet Credits
Coinbase’s support of the August 2017 hard-fork may result in a surprise for users whose wallets were recently credited with BCH: Additional Tax Liability in 2017.
Coinbase's general delay in offering hard-fork support may result in greater tax liabilities to users relative to exchanges that offered support months ago when BCH's fair market value was still relatively low.
BCH Hard-Fork Credits Probably Result In Additional Income for Users In 2017
A fundamental question of first importance is whether the receipt of new currency following a hard fork, such as BCH, results in taxable income.
In the same vein as game show prizes, lottery winnings, and property found or discovered (see for example Barry Bonds’ record home run ball), windfalls and treasure troves such as the receipt of hard-fork currency is more likely than not a taxable event in the eyes of the IRS. In Commissioner v. Glenshaw Glass Co., the Supreme Court laid out a three part test for determining taxable income, and it is still applicable today. Specifically, the Supreme Court held that taxable income exists if there is (1) an instance of “undeniable accession to wealth” (2) that is “clearly realized” (3) over which the taxpayer has “complete dominion.” Moreover, under the doctrine of constructive receipt, an item of income becomes taxable as soon as it’s credited to a taxpayers account or is otherwise made available to the taxpayer to claim. Treas. Reg. § 1.451-2(a).
Accordingly, prior to BCH hitting a Coinbase user’s account, a taxpayer could have argued that they did not meet the above income requirements. Meaning, when nothing was credited to their account, when they had no dominion or control over anything, and they really had no value to tap into or liquidate, they did not have any income. I'll buy that. They couldn’t sell, trade, or transfer their BCH, so how can the IRS tax them at that point? They probably can't.
Now, with the BCH credited into a user’s account, it is freely transferable and tradeable. There appears to an “undeniable accession to wealth” (the BCH’s FMV) that is “clearly realized” (it’s in the account) and over which they have “complete dominion” (they can sell, trade or transfer it). It would be stretch to argue otherwise and upon receipt it is likely deemed income.
Delayed BCH Credits May Have Costed Coinbase Users More In Tax
For anyone in line to receive hard-fork currency now or in the future, the best time to receive it for tax purposes is when its value is at its lowest. This is because the amount of income deemed received is determined by the fair market value of the property received, on the date of receipt.
So for taxpayers whose exchanges credited them with BCH when it was worth $400, their income tax liability may be much lower than those of the affected Coinbase users. On the other hand, the Coinbase HODL of your BCH, at least as of now, definitely resulted in getting you a larger windfall. Had you received your BCH in August, it’s possible you might have already sold it at $400. Who knows? Impossible to tell.
Well, could a Coinbase user take the position that they actually received their BCH once the hard-fork occurred back in August? Anyone can argue anything. But it doesn't mean it makes for a good tax position. Most importantly, it doesn't mean that argument will be in line with the position of the IRS. Following such a taxpayer's logic, they would have planned on claiming income in 2017 for the August hard-fork even if Coinbase never ended up issuing its users BCH in support of the hard-fork.
The issue of when you are in receipt of your hard-fork currency, and by extension, the income, is definitely a catch 22. The IRS has not provided any guidance on how it expects taxpayers to report hard-fork currency income. Given the non-uniformity of the exchanges and their seemingly random approaches, this issue will continue to be problematic until more guidance is provided by the IRS or Congress.
Early Release of BCH Support – Possibly Tax Motivated?
I have no idea why Coinbase went against its originally stated plans and released BCH support before 2018. Perhaps, and I’m just grasping at straws here, Coinbase’s actions were tax motivated. This can come into play a number of ways. First, to avoid putting their users in the precarious tax reporting position of having to decide whether they received BCH income in 2017 or 2018. Second, with the rate that BCH has been growing, perhaps they wanted to credit accounts before the anticipated holiday stay-at-home speculation drove up prices even more. Most people are going to have to liquidate some of their crypto in order to pay their taxes, and the more liquidation the harder it might be for exchanges like Coinbase to keep up. And finally, perhaps Coinbase was trying to get the issue off their plate before 2018 just in case the IRS rolls out reporting guidelines for U.S-based exchanges effective tax year 2018. By getting these credits off the books in 2017, perhaps they avoid a yet-to-be announced reporting issue. Who knows, anything is possible.
Disclaimer: This is for informational purposes only. I am not your attorney and this does not constitute tax advice. Please consult with you own CPA or tax attorney for any guidance about reporting issues related to cryptocurrency.