Do You Need to Pay Taxes on Airdropped Crypto?

Introduction

Airdropped cryptocurrencies have become a common way for blockchain projects to distribute tokens to users. While receiving free crypto may seem like a bonus, it comes with tax implications. Both Canada and the U.S. have specific rules on how airdropped crypto is taxed, and failure to report it correctly can result in penalties. This article explains how tax authorities treat airdrops, when they become taxable, and how you should report them on your tax return.

How Are Airdrops Taxed in the U.S.?

The IRS classifies airdropped crypto as ordinary income at the time it becomes available to the recipient. The taxable event occurs when the tokens are recorded on the blockchain and the recipient has control over them.

• Taxable Event: When the airdropped tokens are available for withdrawal, they are taxed as income based on their fair market value (FMV) at the time of receipt.
• Reporting: The income should be reported as miscellaneous income on your tax return. If the tokens increase in value and you later sell them, that creates a capital gain or loss based on the sale price and the original FMV.
• Example: You receive 500 tokens in an airdrop when each is worth $2, meaning your taxable income is $1,000. If you later sell them for $3 per token, you’ll have an additional $500 capital gain ($1,500 sale - $1,000 initial value).

Airdrops from Hard Forks

• If an airdrop results from a hard fork, the IRS considers it taxable income only if the taxpayer gains control over the new coins.
• Example: If Bitcoin forks and you receive new Bitcoin Cash tokens, those tokens are taxable at the FMV when they become available in your wallet.

How Are Airdrops Taxed in Canada?

The Canada Revenue Agency (CRA) also treats airdrops as taxable, but with a key distinction:

• If you receive an airdrop as a business or part of a commercial activity, it is considered income at fair market value when received.
• If you receive an airdrop as a personal investment, it is not taxed immediately. Instead, tax applies only when you sell the tokens, triggering a capital gain or loss.

Example: Personal Use vs. Business Activity

• Personal Investor: If you receive 1,000 tokens via an airdrop and later sell them for $2,000, you only pay tax on capital gains (profit from the sale).
• Business Investor: If a company or trader receives the airdrop as part of operations, the CRA considers it business income, and it is taxed when received.

How to Report Airdrop Income on Your Tax Return

For U.S. Taxpayers

• Report the airdrop’s fair market value as ordinary income in the year received.
• If sold later, report capital gains or losses on Form 8949 and Schedule D.
• Self-employed traders may owe self-employment tax in addition to income tax.

For Canadian Taxpayers

• If taxed as business income, report the fair market value upon receipt.
• If taxed as a capital gain, report gains or losses only when selling.
• Use Schedule 3 of the T1 tax return to report capital gains.
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How to Reduce Taxes on Airdropped Crypto

• Use deductions: In the U.S., business-related crypto activities may qualify for deductions.
• Report losses: If the value of airdropped tokens decreases before selling, you can use capital losses to offset gains.
• Hold long-term: Holding tokens for over a year in the U.S. qualifies for the long-term capital gains rate, which is lower than regular income tax.

Conclusion

Airdropped cryptocurrency can be taxable income or a capital gain, depending on where you live and how the tokens are received. In the U.S., airdrops are immediately taxable, whereas in Canada, they are only taxable upon sale (unless received as business income). Properly reporting airdropped tokens is crucial to staying compliant with tax authorities.

Tax Partners specializes in crypto taxation and can help you navigate reporting requirements. Reach out to our experts to ensure your airdrop taxes are filed correctly.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.