IRS Clarifies Tax Rules for Digital Assets in Locked Accounts

Crypto rewards received before an account freeze are taxable in the year they're received, even if holders can't access their funds later, the IRS says.

The Internal Revenue Service (IRS) has clarified the tax rules for digital asset rewards received before an account freeze in a memorandum issued in October.

According to the IRS, if a taxpayer receives crypto rewards in an account that is later frozen due to bankruptcy, the rewards are taxable in the year they are received, even if the holder cannot access their funds later on.

This interpretation is based on Sections 61 and 451 of the Internal Revenue Code, which stipulate that income must be recognized in the year it is received, regardless of later inaccessibility.

The IRS memorandum states that if a taxpayer receives digital asset rewards in an account that is frozen before the rewards are credited, the rewards are not taxable until the year they are credited.

However, if the rewards are credited before the account is frozen, they are taxable in the year they are received, even if the taxpayer cannot access them later on.

The IRS also clarified that the fair market value of the rewards is determined on the date when the taxpayer first accessed the rewards.

This ruling is significant as it provides guidance to taxpayers on the taxability of digital asset rewards in the event of platform bankruptcies and account freezes, which have become increasingly common in recent times.