Who doesn’t like the idea of free money? Cryptocurrency airdrops promise exactly that. In some cases, these giveaways can sometimes even involve large amounts of funds. There is, of course, a catch: airdrop income can have a significant impact at tax time. Keep reading to learn more.
What is an airdrop?
An airdrop is essentially a marketing tool. When a new coin comes out, the project associated with it will often negotiate deals to give it out through a variety of different channels.
Sometimes, airdrop recipients have to complete a series of tasks to collect the free money. Other times, airdrops are sent out automatically. The creators of Flare network opted for the later approach when they took a snapshot of Ripple’s XRP ledger last month, which will dictate how many Spark tokens XRP holders will receive when the airdrop takes place.
Anyone who owned XRP on select exchanges last December 12th was eligible to receive the airdrop. Coinbase, Kraken, Binance, Bitstamp and several other major exchanges participated in the airdrop. (Click here for the full list.)
What are the tax implications of an airdrop?
The situation is a bit of a grey area. However, the IRS’s recently released cryptocurrency FAQ page does clarify some basic points.
“A22. 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 statement conclusively states that airdrops are taxable. However, there is no specific guidance regarding how one should determine the value of an airdrop.
Calculating the tax value of your airdrop
The most conservative approach is to set the cost basis (in other words, the initial value of the asset) to its price at the time that the airdrop took place. We can use an example to clarify this point. Let’s say that the 100 coins you received during an airdrop were worth $1 each. For tax purposes, the airdrop would cause your ordinary income to rise by $100.
A more aggressive and controversial strategy would be to set the cost basis to zero. The main advantage of this approach would be that your tax obligation would be zero until you cashed in your airdrop. Keep in mind that once you make that move, however, your tax obligation will be significantly higher later on if the airdrop increases in value. In addition, choosing this option may not stand up to scrutiny in the event that you are audited in the future.
To illustrate how using the first cost basis method can potentially result in long term savings, let’s go back to the example mentioned above. Let’s say that the price of the airdropped coin rises from $1 to $2 and you decide to cash out. If your initial cash basis was zero, you’d have to incur a $200 increase to your capital gains income at the time of sale. But if your initial cost basis was $100, then you’d only incur a $100 capital gain. Using this approach, you could split up your gains between two different tax years.
Need airdrop advice?
Contact Founder’s CPA today and set up a free consultation today. Our CPAs are experts in the area of cryptocurrency, especially when it comes to meeting the needs of small businesses and entrepreneurs.