Bitcoin Cash and Taxes… in the Age of Cloning Crypto

On August 1st, Bitcoin split.  Welcome to the world, Shuya Yang!

If you held Bitcoin (BTC) before the split, you now hold an equal amount of Bitcoin Cash (BCH).  The same private key provides ownership to both assets.

Having split, all Bitcoin key holders now face a higher tax bill for the year.  Yes, even the small block Segwit(2X) UASF camp who want nothing to do with Bitcoin Cash.

Which leads to a curious question, do you need to pay taxes every time some Tom, Dick and Harry decides to clone Bitcoin?

The Distribution

Here’s what my clever accountant friends tell me.

What happened is not a stock split.  That would have required a formal plan to execute a price-adjusted split between the two coins.  For example, if you owned $1,000 worth of BTC, after the split you would still own $1,000 worth of combined BTC and BCH.

Instead, the creation of your free coins is analogous to receiving a dividend payment.  You hold an asset BTC which on August 1st distributed BCH to you.  As far as the taxman is concerned, the fiat value of BCH which you received is going to be taxable.

Of course, opinions may differ – maybe it’s a stock spin-off – and there are different rules for different jurisdictions, so consult your tax adviser.  For those in the U.S., GreenTraderTax has some good advice.

American Bitcoiner

Here’s a typical example for those in the U.S. where the IRS treats BTC as property for federal tax purposes.

  • You hold 10 BTC
  • Average price of BCH over the first day was ~$400 (maybe the opening price of ~$200 could be used instead, or even $0… note that a futures market existed before the split)
  • You received “other income” of $4,000

A table showing the various rates of dividend income tax based on ordinary income.Let’s say you’re in the 28% tax bracket.  If a case could be made that the distribution of BCH is a dividend and you’re a long term BTC holder, your “other income” might be taxed at the qualified dividend rate of 15%.

However, it’s most likely that the distribution is treated as “other income” so the $4,000 will be taxed at your ordinary income rate of 28%, meaning you’ll owe $1,120.

You might decide to sell some of your BCH to cover the taxes due… however because virtual currencies are treated as property in the US, you’ll have to pay capital gains tax when you sell it.

The cost basis for your BCH should be the fair market value at time of receipt.  Let’s say you’re a good trader and when the price spiked on August 2nd you managed to sell all your BCH for $6,000.  That would net you a short-term capital gain of $2,000 which gets taxed at 28%.

The Numbers Nightmare

Let’s see how our example adds up:

  • You’re in the 28% tax bracket
  • You purchased 10 BTC a month before the split
  • You received 10 BCH on August 1st, worth $4,000
  • You now owe income tax of $1,120
  • On August 2nd, you sold it all for $6,000, a gain of $2,000
  • You now owe capital gains tax of $560

After taxes of $1,680, you’re left with $2,320.  Not too shabby for holding BTC and clicking a few buttons.  However, there is a nightmare scenario.  If you simply hold and the price of BCH falls to $150, your 10 BCH would be worth $1,500 which is less than the taxes owed!

Questions Galore

Should you have to pay taxes on cloned coins which you want nothing to do with?  I’m sure accountants and tax lawyers are already trying to figure this one out.

A hard fork and clone of the existing ledger forces new coins onto you.  There’s no way you can reject ownership of the new coins since you already possess the private key to them.  The situation is somewhat akin to how a company can issue a dividend even if some shareholders are against the idea.

However, what’s to stop another group cloning Bitcoin and listing it on an exchange somewhere at a crazy high price with fake trading volumes to ‘legitimize’ the clone?  The taxes could bankrupt people.

What criteria will tax authorities apply to determine which clones you pay taxes on?  It seems the rational answer might be all of them… since it’s a fairly cheap way to fill up the coffers.  Cloning crypto could become a novel way to raise tax revenue!

Final Thought

The sting in the tail for those who want Bitcoin Cash to fail is that they really need it to succeed, in order to avoid ending up out of pocket.

 

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3 thoughts on “Bitcoin Cash and Taxes… in the Age of Cloning Crypto

    1. Thanks, that’s another way to look at it. I updated the post to link to your blog. In your scenario, say with 1 BTC, where the pre and post value differs, $2,700 (BTC) to $3,100 (BTC+BCH) is there tax due on the difference?

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  1. Alternative interpretation:

    The blockchain fork took an asset you have and broke it into separate parts. That’s similar to, say, buying a set of jewelry and then selling the pieces separately. So the cost basis of the new asset will be split between the new assets, proportionally to their FMV (when?), while keeping the total basis and date unchanged.

    The key point is that “Bitcoin” vs. “Bitcoin Cash” are just words. Technically, the two chains have the same technical standing, and both chains date back to 2009. The situation is symmetric, except for market value. So it doesn’t make sense to treat one chain as a dividend of the other, or to say that one of the chains was created on Aug 1st 2017.

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