What Is An Airdrop In Crypto?

What Is An Airdrop In Crypto? Understanding Tax Implications Of Crypto Airdrops

In the rapidly evolving landscape of cryptocurrency, one trend gaining significant traction is the concept of airdrops. Airdrops, pivotal in the blockchain project community, not only offer a means for holders to receive free new tokens but also introduce intricate tax implications. Understanding these airdrop tokens and their tax implications is paramount for anyone navigating the legitimate crypto space.

Understanding How Crypto Airdrops Work

What is a Crypto Airdrop? 

A crypto airdrop is a marketing strategy adopted by blockchain-based startups to bootstrap their projects. Participating in an airdrop involves the free distribution of new tokens to potential users’ digital wallets. This airdrop is a marketing strategy that aims to enhance engagement, distribute tokens widely, and add value to the blockchain project.

Types of Crypto Airdrops

Manual Claim Airdrops

Usually, these airdrops require users to complete certain tasks, like social media engagement or signing up for a newsletter, to receive the airdrop. These holder airdrops might also be considered bounty airdrops. The participants can then claim the airdrop tokens from a smart contract.

Automatic Distribution

This type of airdrop involves crypto projects automatically sending free tokens to wallets that are eligible for the airdop. This is often based on their current holdings. This is the standard airdrop used by most projects.

Exclusive Airdrops

These airdrop campaigns are designed for dedicated supporters or early adopters of cryptocurrency projects. Exclusive airdrops are often used to reward investors for their loyalty or early interest. The airdrops are usually automatically distributed to eligible crypto wallets.

Purpose and Benefits

Participating in airdrops serve multiple purposes: airdrops are a way to generate buzz, incentivize participation, and often increase a blockchain project’s user base significantly. Airdrops can be a great way to create a decentralized crypto community of token holders.

Taxation of Crypto Airdrops in the United States

The Internal Revenue Service (IRS) in the U.S. considers most airdrops as ordinary income. The taxable amount is based on the market value of the airdrop tokens at the time they are received for free by the holder.

Calculating Taxes on Cryptocurrency Airdrops

Step-by-Step Airdrop Tax Calculation

To calculate the tax due from participating in an airdrop, you need to determine the fair market value of the airdropped tokens at the time you gain access to them.

There are a number of possible ways to determine the value of the tokens airdropped. 

If the tokens were received on an exchange, you can use the market value for the tokens on that exchange at the time the tokens were received.

If the airdrop was received into a self-custody wallet, you could take the average price of the token on the top 3 exchanges by trading volume at the time the airdrop was received.

If the tokens were airdropped before liquidity was available or trading has commenced, it is possible that the fair market value of the tokens is $0.

You can also set up a crypto tax software which, if a price feed exists for the token, can help determine the value of the airdrop for you.

Once the value of the airdropped tokens is determined, that is both taxable income AND becomes the cost basis for your tokens.

Case Studies of Successful Airdrops

Apecoin Airdrop

Yuga Labs, the creators of Bored Ape Yacht Club (BAYC), introduced the APE Foundation by airdropping ApeCoin tokens in one of the most famous airdrops of 2022.

The airdrop distributed ApeCoin, the governance token for APE Foundation, to eligible community members who held either a Bored Ape Yacht Club (BAYC) or Mutant Ape Yacht Club (MAYC) NFT by Yuga Labs.

Many BAYC & MAYC holders received tokens valued at over $100,000.

And they didn’t realize that they owed taxes on their airdrop!

BAYC holders who received their 10,950 APE tokens valued at $7.26 each had an income tax liability of $79,497.

But they also had a cost basis of $79,497 for their tokens.

Many investors who received the APE airdrop sold their tokens the next day when ApeCoin doubled in price to $15.

This also created a capital gains event.

10,950 APE sold for $15 each leads to proceeds of $164,250

To calculate the capital gain we take proceeds of $164,250 and subtract the cost basis of $79,497 to arrive at a gain of $84,753.

Reporting Airdrops in Tax Returns

Required Tax Forms

Generally, you will report airdrops as “other income” on IRS Form 1040 and if you sell the airdrop the capital gain or loss is reported on Form 8949.

A tax professional, or crypto tax software like Koinly can help you prepare these forms.

Documentation of Airdrop Transactions

Keeping detailed records of airdrop events, values, and subsequent trades is crucial for accurate tax reporting. You can reference the blockchain scanner for where the airdrop occurred to get the transaction details.

For example, because the APE coin airdrop occurred on the Ethereum blockchain, you could add your wallet address to etherscan.com to find the details of your APE airdrop.

However, this is a tedious process. And my recommendation is to set up a crypto tax software like Koinly which will automatically pull the data off the blockchain and might be able to help you determine your airdrop tax liability.

International Perspectives on Crypto Airdrop Taxation

Similar to the US, the ATO in Australia views airdrops as income. The rules are similar to the IRS in the United States.

The CRA in Canada, and the BZSt in Germany are examples of tax offices that may not consider airdrops as income if they were earned without effort. 

This means they would be treated as a $0 cost basis acquisition. So if you received the APE airdrop and sold for $164,250 you would pay capital gains tax on the full amount of the sale.

Other tax offices like the HMRC in the United Kingdom have more nuanced rules to determine the taxation of airdrops. 

For example, if you are considered a professional trader, then airdrops may be taxed as income. However, if you are not a professional trader and received an airdrop without effort, it would not be taxed as income.

Professional Advice and Tax Planning for Crypto Airdrops

Importance of Tax Professionals

Expert advice is essential to navigate the complexities of crypto taxation effectively. There are a few different options 

Tax Planning Strategies

We will discuss strategies to help crypto investors remain compliant and optimize their tax situations.

Conclusion:

Navigating the realm of cryptocurrency airdrops requires a keen understanding of both their potential benefits and the accompanying tax responsibilities. While airdrops offer an exciting avenue for expanding one’s crypto portfolio, they also bring complex tax implications that demand careful attention. Staying informed about the latest tax regulations and meticulously documenting transactions is crucial for compliance and financial well-being. In essence, effectively managing airdrops goes beyond mere participation; it involves strategic planning and a proactive approach to tax planning. By balancing these elements, enthusiasts and investors alike can fully leverage the opportunities presented by airdrops while navigating the intricacies of cryptocurrency taxation.

FAQs:

What exactly is a cryptocurrency airdrop?

An airdrop in cryptocurrency is a distribution of digital tokens or coins, usually for free, to numerous wallet addresses. Airdrops are often used as marketing tools to increase awareness of a new cryptocurrency.

Are cryptocurrency airdrops considered taxable events?

Yes, in many jurisdictions, including the United States, cryptocurrency airdrops are considered taxable events. The recipient typically owes taxes on the fair market value of the airdropped tokens at the time they gain control over them.

How do I determine the value of airdropped tokens for tax purposes?

The value is generally determined based on the fair market value of the tokens at the time they become accessible to you. This information can often be found on various cryptocurrency exchange platforms or financial news websites.

Do I have to pay taxes on airdropped tokens that I didn’t ask for?

Yes, even unsolicited airdrops are subject to taxation. The IRS views receiving such tokens as a form of income, regardless of whether the recipient requested them.

What should I do if the value of my airdropped tokens drops significantly?

If the value drops after you have received them, you can realize a loss when you dispose of them. However, the loss can only be claimed for tax purposes at the time of their sale or exchange, not when the value decreases.

How are airdrops taxed in countries outside the United States?

Taxation of airdrops varies by country. Some countries, like the UK and Australia, treat them as both income and subject to capital gains tax, while others have different approaches.

What forms do I need to use to report a crypto airdrop on my tax return?

In the United States, you typically report income from airdrops on IRS Form 1040 (Schedule 1) and any capital gains or losses on Form 8949 and Schedule D.

If I receive an airdrop but cannot access the tokens immediately, when do I get taxed?

You are taxed when you have dominion and control over the tokens, which usually means when they are accessible and transferable by you.

What if I receive a token from an airdrop that isn’t listed on any exchange?

If the token isn’t listed, its fair market value might be unclear. In such cases, it’s advisable to consult with a tax professional to accurately determine its value for tax purposes.

Can I refuse an airdrop to avoid tax liability?

Generally, refusing an airdrop is not possible, especially for automatic distributions. However, if you have the option to claim an airdrop manually and choose not to, you won’t incur any tax liability.

How to Avoid Airdrop Scams

Many crypto scams involve a process where free tokens are sent to a crypto wallet, but the token has malicious code which may ask the user to approve transactions which give the scammer access to withdraw other tokens in their wallet. 

These airdrops will often have names similar to legitimate airdrops, so the fake airdrop token is sometimes mistakenly approved by investors.

The best way to avoid airdrop scams is to verify the airdrop is legitimate. You can do this by checking the contract address on a website like CoinMarketCap or CoinGecko. If the contract address on a verified source does not match the contract address of the token in your wallet, you have a fake token in your wallet. Do not try to sell, transfer, or otherwise interact with that token.

How Do Crypto Airdrops Work?

Crypto airdrops work by distributing free tokens or coins to cryptocurrency holders.

These airdrops are typically used as a marketing strategy by new or existing blockchain projects to create awareness and promote their digital assets. To participate in a crypto airdrop, users usually need to meet certain criteria, such as holding a specific amount of a particular cryptocurrency in their wallet or being an active user of a certain platform.

Airdrops can also be used as a way to reward existing token holders or to encourage participation in a new project. Once the conditions are met, the free tokens or coins are usually distributed directly to the participants’ cryptocurrency wallets. Crypto airdrops have become a popular way for blockchain projects to distribute their tokens and grow their user base while gaining exposure within the cryptocurrency community. 

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