The IRS has issued guidance (Rev. Rul. 2023-14) addressing the tax consequences of a hypothetical cash-method taxpayer who stakes cryptocurrency native to a proof-of-stake blockchain and receives additional units of cryptocurrency as reward when validation occurs.
Many cryptocurrencies use blockchain technology as a digital ledger, which involves a consensus mechanism for updates to the blockchain. The ruling describes the consensus mechanism referred to as “proof-of-stake,” in which holders of cryptocurrency may participate in the validation process by “staking” their holdings if they hold a requisite number of units of a particular cryptocurrency. If a holder is chosen by the protocol, and validation is successful, the holder will receive a reward. However, if a validator is chosen and the validation is unsuccessful, the staked units may be subject to penalty with the staked units being forfeited.
The revenue ruling considered the treatment of a hypothetical cash-method taxpayer, A, who owned 300 units of a cryptocurrency, M, on Date 1. Transactions in M were validated by a proof-of-stake consensus mechanism. A staked 200 of M units and validated a new block of transactions on the M blockchain, which resulted in A receiving two units of M as validation reward. During a brief period ending on Date 2, A lacked the ability to sell, exchange or otherwise dispose of the two M units. However, A had the ability to sell, exchange, or otherwise dispose of the two units of M on a specified date, Date 3.
The IRS ruled that A had an accession to wealth under Section 61 and the principles of Commissioner v. Glenshaw Glass Co. (348 U.S. 426 (1955)) when A gained dominion and control from the ability to sell, exchange, or otherwise dispose of the two units of M received as validation rewards. Accordingly, the IRS ruled that the fair market value of the two units of M were included in A’s gross income for the taxable year that included Date 3. The fair market value of the two units of M was determined as of the date and time that A gained dominion and control over the two units of M.
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