Cryptocurrency forks
A cryptocurrency fork occurs when developers or a community decide to modify the rules of a blockchain network, creating two versions that can no longer operate on the same chain.
Forks often happen when stakeholders disagree on governance issues, want to introduce new features, or need to fix security vulnerabilities. This process can lead to both “soft forks” and “hard forks,” each with its own technical and tax considerations.
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What is a hard fork?
A hard fork in crypto is a major protocol update that makes previously invalid blocks (or transactions) valid or vice versa. Because new rules introduced in the fork are not backward-compatible, the original chain and the new chain diverge permanently.
A hard fork crypto event essentially duplicates the existing blockchain at a certain block height, creating a brand-new token on the new chain. If you held the original token prior to the fork, you typically end up holding both the old and new tokens.
When do hard forks occur?
Hard forks may arise when a blockchain community votes on a significant upgrade or when a central development team decides that the existing protocol must change. Sometimes, these forks resolve contentious debates—such as the well-known disputes in the Bitcoin and Ethereum communities—or address urgent security matters.
In other cases, a hard fork might be planned well in advance to introduce major improvements. Whenever such a fork is implemented, the chain splits into two paths, and tokens on each chain may have different values or functions.
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Hard forks vs soft forks
While a hard fork creates an entirely separate blockchain and a new token, a soft fork is a protocol change that remains compatible with the existing chain. In a soft fork, nodes running the updated software can still communicate with nodes using the old version, meaning no new chain—and thus no new token—is born. From a tax perspective, soft forks often have minimal impact because they do not create additional tokens that could be considered taxable income.
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Crypto hard fork taxes explained
Under current IRS guidance (Rev. Rul. 2019-24), tokens received from a crypto hard fork are generally taxed as ordinary income based on their fair market value when they are deposited into your wallet. Later, if you sell, trade, or otherwise dispose of those tokens, you will incur a capital gain or loss. These principles also apply to many airdrops that result from crypto forking events.
Airdrops income example
Imagine you held 15 BTC before the Bitcoin Cash (BCH) hard fork. After the fork, you still have 15 BTC on the original chain and now also receive 15 BCH. Suppose those 15 BCH were worth $4,335 at the time they hit your wallet. That $4,335 is treated as ordinary income and taxed according to your income tax bracket.
Airdrop capital gain example
Continuing the previous scenario, let’s say you later sell your 15 BCH. When you received the BCH, it was worth $4,335 (your cost basis). Five years down the road, its value drops to $1,625. If you sell at $1,625, you would realize a $2,710 capital loss ($4,335 – $1,625). That loss can offset other capital gains you might have, possibly reducing your tax liability.
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How does the IRS tax cryptocurrency forks?
The IRS states that new tokens received via a hard fork are to be reported as ordinary income. The amount of income you report equals the fair market value of the new tokens when you gain control over them. If you don’t claim or otherwise take control of the tokens at the time of the fork, you don’t owe tax until you do so—although recordkeeping can become tricky, especially if the tokens’ value changes significantly after the fork event.
Once you have established your cost basis (i.e., the fair market value at receipt), any subsequent disposal will be taxed according to short-term or long-term capital gains rules. Keeping detailed records of when you received the forked tokens, their value, and when you sold them is vital to accurately calculate capital gains or losses.
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