Cryptocurrency holders often want to put their assets into an entity for a host of reasons, such as asset protection, arranging negotiated management rights and exit planning. This post discusses basic federal income tax issues related to holding cryptocurrency inside a partnership (meaning any entity taxed under Subchapter K* of the Internal Revenue Code; the “Code’).
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Cryptocurrency: The Basics of Tax Treatment and Recognition
Cryptocurrencies might, simplistically, be defined as virtual currencies that use cryptography to secure transactions which are digitally recorded on a widely distributed ledger. The ledger technology uses independent digital systems to timestamp and harmonize transactions. The cryptocurrencies associated with a ledger are often called “coins” or “tokens”.
Cryptocurrency can be acquired in multiple ways. This post covers only common methods, such as purchase, gift, or airdrop following a hard fork. A hard fork occurs when a ledger is subject to modifications that “break” compatibility with an earlier protocol; in other words, each leg of the fork follows different “rules” so the blockchain ledger is split into an original chain and new chain. Hard forks sometimes result in the creation of a new cryptocurrency. An airdrop is a method of distributing cryptocurrency units to the ledger addresses of individual taxpayers. Airdrops sometimes, but not always, follow hard forks. While blockchain technology is interesting, and an elementary understanding of its technological mechanics is useful, it is the tax consequences of the receipt and disposition of cryptocurrency which is the subject of this post.
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