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Crypto Taxes
Crypto Taxes

Airdrop Taxes 101: What Investors Need to Know

Receiving an airdrop can bring cryptocurrency users thousands of dollars of value in an instant. Unfortunately, it also comes with an associated tax liability. 

In recent years, an increasing number of cryptocurrency projects have airdropped tokens to users. While it can be a great way to reward early adopters and true believers, it can also become a headache for investors filing their tax returns. 

In this guide, we’ll break down the IRS’s guidance on airdrop taxes (and share a couple of tips on avoiding airdrop-related tax issues). 

What is an airdrop? 

In an airdrop, cryptocurrency projects freely distribute tokens to early users and investors. It’s seen as a way to build awareness for the project, reward early evangelists, and foster a burgeoning community. 

Many successful cryptocurrency projects have leveraged airdrops. In September 2020, the decentralized exchange Uniswap airdropped 400 free UNI tokens to early users. More recently, in November 2021, Ethereum Naming Service (ENS) airdropped the ENS governance token to all users who had previously purchased an ENS domain. In both scenarios, recipients of these airdrops reaped thousands of dollars of value.

How are airdrops treated from a tax perspective?

IRS guidance states that airdropped cryptocurrency rewards should be treated as ordinary income based on its fair market value at the time it was received and will be taxed based on the individual’s tax bracket. 

Airdrop taxes

Typically, cryptocurrency investors are used to reporting taxes only in the case of a disposal, such as a sale or trade. However, it’s important to keep in mind that airdrops need to be reported as income even if there is no disposal event. 

Where do I report airdrop rewards on my tax return? 

For most investors, airdrop rewards should be reported on Form 1040 Schedule 1 as ‘Other Income’. A description such as “crypto airdrop”, should be entered on the line item.

Does airdrop income get taxed twice? 

Just as you would report gain or loss on the sale or exchange of any token, you would also report the gain or loss on the sale or exchange of an airdropped token. You are not, however, taxed on the same income twice.

As mentioned earlier, airdrop rewards are taxed as ordinary income based on their fair market value at the time they are received. If a disposal occurs, you will only be required to incur capital gains or losses based on how the price of your tokens has changed since you originally received them. 

Here’s an example of how this works. 

Cryptocurrency airdrop income and gains tax example

Common airdrop issues 

While airdrops can be a great way to reward crypto investors, they often come with their own issues. Here are two common ones. 

I lost money in an airdrop scam 

Unfortunately, airdrops can be used to scam unsuspecting cryptocurrency investors. Some phony projects ask for investors’ private keys, then use this information to steal the assets contained within their wallets.

If you’ve been the victim of an airdrop scam, check out our guide for how to report lost or stolen cryptocurrency on your tax return

The price of my airdropped tokens has declined significantly 

Remember, you will be required to pay income taxes based on the fair market value of your tokens at the time they were airdropped to you. However, this may be an issue if the token’s price declines significantly. In this case, it’s possible that you may need to pay more money in taxes than you currently have available. 

To avoid this scenario, we recommend using a crypto tax software that can help you track your tax liability throughout the year. 

How will the IRS know if I got an airdrop? 

Some investors choose not to report airdrop rewards, believing that the IRS will not be able to trace the transaction. 

However, not reporting airdrop rewards is a form of tax evasion and could come with severe consequences. 

The IRS employs the services of third-party companies such as Chainalysis to match anonymous wallets to investors. Not reporting your income increases the risk that you’ll face a cryptocurrency tax audit and possibly face jail time. 

File your crypto taxes in minutes 

With CryptoTrader.Tax, reporting airdrops on your taxes is easier than ever. The platform allows you to report income from airdrops in minutes. 

CryptoTrader.Tax Airdrop import

In addition, you can automatically import transactions from exchanges such as Coinbase, Kraken, and Gemini. When tax season rolls around, all you have to do is check to see if your information is correct and file your tax return. 

Get started with a free account today

Recently updated on
November 10, 2021
Category:
Crypto Taxes

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