With the initial phase of the migration to Ethereum 2.0 underway, it’s time to take a look at the tax implications that come with participating in the new protocol.
Our tax professionals here at CryptoTrader.Tax have deep dived into these implications, and we discuss how Etherem 2.0 taxes work within the US below. Similar rules apply within other countries.
Because Ethereum 2.0 will be completely replacing Ethereum over time, it’s reasonable to determine that you will not incur a taxable event when converting ETH to ETH 2.0.
The IRS has been consistent with its stance that trading one cryptocurrency for another triggers a taxable event and realizes a capital gain which must be reported on your taxes.
However, in the case of moving from ETH to ETH 2.0, token holders are converting ETH on a 1:1 basis for ETH 2.0, and the original ETH gets burned in the process.
As the IRS made clear with their most recent cryptocurrency revenue ruling, a hard fork occurs when the original protocol continues to operate apart from the newly “forked” protocol. This was the case with the Bitcoin Cash hard fork in 2017 (and holders of BTC recognized income for the amount of BCH received).
Unlike Bitcoin Cash, the ETH 2.0 token is completely replacing the old ETH. Thus, Ethereum 2.0 falls outside of the scope of this hard fork definition, and the protocol is more accurately going through an ‘upgrade’.
It’s reasonable to infer that your cost basis from your original ETH holdings will transfer over to your ETH 2.0 upon conversion.
This means that whenever you sell or dispose of your ETH 2.0 in the future, you trigger a capital gains tax event where you will realize a gain or loss depending on the market price of ETH 2.0 at the time of disposal.
Mark acquired 10 ETH back in 2018 for $1,000 total. In 2020, he converted his 10 ETH for 10 ETH 2.0.
At this point, no taxable event has occurred, and Mark’s cost basis in the 10 ETH 2.0 is $1,000.
Three years later, Mark sells all 10 ETH 2.0 for $50,000. In this case, Mark incurs a $49,000 capital gain which gets reported on his taxes.
As discussed in our crypto mining and staking tax guide, crypto that is earned from staking is generally treated as income equal to the fair market value at the time it is received.
Due to the lockup period associated with the validator rewards of ETH 2.0, crypto tax professionals and attorneys within the Ethereum community have debated whether your staking rewards trigger income at the time they are “earned”—as they are earned during this lockup period.
There is no clear guidance from the IRS or other tax authorities on this matter, however the most conservative views suggest that you do incur income as you accrue validator rewards from staking your ETH 2.0, even though you can’t access it.
This is frustrating, and it’s unfortunately a gray area for cryptocurrency users. Our team at CryptoTrader.Tax is urging the IRS to pass further guidance on the matter.
Remember, when you first earn your ETH 2.0 validator reward, you recognize income at the fair market value of the coin when it was received. The income you recognize becomes your cost basis moving forward.
Once you sell your ETH 2.0 or trade it for another cryptocurrency, you realize a capital gain or loss based on how the asset has fluctuated in price since you recognized the income.
Stacy earns 1 ETH 2.0 via validator reward on July 22nd. At this time, the 1 ETH 2.0 is worth $3,000.
Stacy recognizes $3,000 of income on July 22nd, and that income gets reported on her taxes. Stacy’s cost basis for that 1 ETH 2.0 is now $3,000.
One year later, Stacy sells that 1 ETH 2.0 for $2,500. In this case, Stacy realizes a $500 capital loss from disposing of her crypto, and that $500 gets deducted from her total taxable income for the year, thus reducing her tax liability.
For a complete general overview of how cryptocurrency taxes work, checkout our Ultimate Crypto Tax Guide.
Cryptocurrency tax software like CryptoTrader.Tax can be used to automate the tax reporting for your ETH 2.0 staking, and all of your other crypto transactions.
By integrating directly with the exchanges, blockchains, and protocols that you use, CryptoTrader.Tax can generate your gains, losses, and income reports from your historical transactions with the click of a button.
You can join over 100,000 other crypto investors and find out your portfolio gains and losses as well as calculate your taxes by creating a free account here.
Our team is happy to answer your crypto tax questions. Just reach out to our support team, and we will get back to you.