How are Airdrops Taxed? Complete Guide With Calculator. - Internal Revenue Code Simplified (2024)

” How are airdrops taxed ?” is a very common question. For this reason, this post covers all the taxation issues related to airdrops of cryptocurrencies- taxation of receipt and its transfer, including reporting on the tax return. Blockchain networks often airdrop their coins to their community members’ digital wallets for various reasons. Airdropping is a method of quickly and efficiently distributing cryptocurrencies to many people at once, and it involves sending tokens or coins to multiple addresses in a single transaction.

What airdrop means?

Airdrop of cryptocurrency or a token is the distribution of free coins or tokens to individuals who either hold the cryptocurrency related to the blockchain already, or the individual is taking part in a specific event or activity conducted by the cryptocurrency network. Airdrop means sending the crypto coins to an individual’s wallet automatically for free.

How does the blockchain network airdrop its coins?

The method that a blockchain network would typically apply for airdropping its coins is first to create a smart contract that specifies the rules and conditions for the airdrop. The smart contract would contain the list of addresses to which the tokens or coins will be distributed, the amount of tokens or coins to be distributed to each digital address, and the date and time when the airdrop will occur.

Once the smart contract is made, the network starts the airdrop by sending the number of tokens or coins listed in the smart contract to the addresses on the list. The airdrop is usually done in a single transaction, and the tokens or coins are sent directly to the recipients’ wallets.

The recipient does not need to take any additional action to receive the airdropped tokens or coins because they are sent automatically to their wallet once the airdrop is complete.

Why do they airdrop cryptocurrencies?

A blockchain network company may adopt airdropping of its token or coins to its community members, or even non-community members, primarily for two reasons:

1. Creation of new coins due to Hard Fork– Please read the previous article on the taxation of cryptocurrencies received due to the hard fork of a blockchain network.
2. Marketing of blockchain network– Blockchain networks adopt airdropping to promote their cryptocurrency and increase adoption. By distributing cryptocurrency to many people, the blockchain company can raise awareness of its project and attract new users. Airdropping can also increase the liquidity of the cryptocurrency by creating more trading activity. Additionally, airdropping can incentivize people to hold onto the cryptocurrency for longer, contributing to a stable market value.

Taxation of Receipt of Airdropped Cryptocurrencies

IRS issued its Revenue Ruling 2019-24: which guides the taxation of airdrops of cryptocurrencies. One of the two questions that IRS has answered in the said RR is the following :

(2) Does a taxpayer have gross income under § 61 as a result of an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of new cryptocurrency?

The answer given by the IRS can be summarized as follows:

1. If a taxpayer receives an airdrop of a cryptocurrency in a wallet that the taxpayer controls, the taxpayer will have a taxable income equivalent to the fair market value (FMV) of the new crypto coins received via airdrop will be determined by the exchange rate on a cryptocurrency exchange that is available to the taxpayer.
2. The accounting system followed by the taxpayer will decide in which year the receipts via airdrop are taxable. If the taxpayer follows the cash accounting method, the FMV of the crypto will be taxable in the year of receipt. If the accrual method of accounting is followed, the FMV of the cryptocurrency will be included in the taxable income of the year when the taxpayer gets the right to receive the cryptos.
3. The taxpayer’s basis in the new cryptocurrency will be equal to the fair market value of the new cryptocurrency at the time it is received.

How is the gain on sale or trade of airdropped cryptos computed?

Since the cryptocurrency is considered “property,” transfer, sale, or trade shall result in short-term or long-term capital gains tax.If you sold the airdropped cryptos after holding more than 12 months, the gain or loss should be short-term. Similarly, if you sell /exchange/trade after holding the airdropped cryptocurrencies for over 12 months, it is long-term capital gains.

Example :

Suppose you receive 100 units of a cryptocurrency called CRYPTON as an airdrop. At the time of receipt, the fair market value of CRYPTON is $20 per unit, making the total value of the airdrop $2,000. This amount will be the taxable ordinary income and must be reported on your tax return (read below ).

Capital Gains

• Let’s say you decide to sell the 100 CRYPTON units at different times and prices. It may result in short-term or long-term capital gains or losses.
• Short-term capital gains: You sell 100 CRYPTON units after holding them for six months (holding period below one year), and the price has increased to $25 per unit. The short-term capital gains will be $2500-$2,000= $500
• Long-term capital gains: You sell the remaining 100 CRYPTON units after holding them for 13 months, and the price has increased to $30 per unit. You will have long term capital gains of $30×100 -$20×100= $1,000.

Here’s a table summarizing the transactions and computations for short-term and long-term capital gains:

The following assumptions are made in the above examples

• The short-term capital gains tax rate is 35% (This is hypothetical. It will be based on your ordinary income tax rate)
• The long-term capital gains tax rate is 15% (This is also hypothetical. The long-term capital is based on your income level)
• The cost basis for each XYZ unit is $10 (fair market value at the time of the airdrop)

Calculator for capital gains on airdropped Coins

This cryptocurrency calculator is based on the principle that the basis of cryptocurrency is the FMV on the date of receipt , as explained above.

Record Keeping of Airdropped Cryptos

Taxpayers who use cryptocurrency must keep detailed records of their transactions to report taxable events accurately. The following records for each transaction will help establish the receipts of airdropped cryptos:

1. Name of coins and the network it represents
2. Date of the receipts of crypto coins via airdrop
3. The number of cryptocurrencies received in the taxpayer’s wallet.
4. The cryptocurrency’s fair market value at receipt of airdropped cryptocurrencies.
5. The exchange or wallet used for the transaction

There is no threshold value for record maintenance in the case of crypto trades. Taxpayers must keep records of all cryptocurrency transactions, no matter how much money was exchanged.

How to report airdrops on taxes?

First of all, Form 1040 for the tax year 2022 onwards contains an explicitly visible question regarding “Digital Assets,” which means anything related to blockchain. The cryptocurrency or token you received falls under the “Digital Asset. ” Now . this questionnaire field is required, which means you can not skip it. If you skip, it is sure that the IRS system will flag your tax return for IRS audit.

Report of receipt of cryptocurrency on airdrop as ordinary income

If you have received cryptocurrency on airdrop for any reason from any blockchain network, you must tick the answer Yes in your Form 1040, and the FMV value must be shown as ordinary income in Schedule 1, Additional Income and Adjustments to Income. You should use the last field, 1(z), to include the FMV value of the airdropped crypto or any digital asset.

Reporting capital gains on cryptocurrency received on airdrop

If during the year you sold or exchanged, or transferred the cryptocurrency that you received on airdrop, you will have to fill two forms -details of sales on Form 8949, Sales and Other Dispositions of Capital Assets, and then capital gain or losses onForm 1040, Schedule D, Capital Gains and Losses.

Conclusion on ” how are airdrops taxed “

The fair market value (FMV) determined as per the crypto exchange where the said cryptocurrency or token is listed on the date and time of receipt of the cryptocurrency or token in the wallet of the taxpayer is taxable as ordinary income at the normal tax rates applicable to the taxpayer for the tax year in which the said airdrop of coins was made.

If you sell or trade or exchange that airdropped cryptocurrency, it may give rise to capital gains or losses as per the holding period. The FMV on the date of receipt of airdropped crypto coins will be the basis for the computation of capital gains.

Hope you understood the answer to the question, ” How are airdrops taxed ?” .For further reading, please visit IRS FAQs for more on virtual currencies.