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How ETH 2.0 Will Impact Your Tax Bill

How ETH 2.0 Will Impact Your Tax Bill

Wondering whether Ethereum 2.0 will increase your tax bill? 

The initial phase of the migration to Ethereum 2.0 is already underway. Many in the crypto ecosystem are hopeful that the shift can lead to faster transaction times and lower gas fees. Unfortunately, many are also worried about the potential tax implications of the migration. 

Our team of tax professionals has spent time analyzing how the IRS may tax Ethereum 2.0 based on existing guidelines. In this guide, we’ll break down the tax implications of the migration — whether you’re holding, staking, or planning to sell. 

What is Ethereum 2.0? 

Ethereum 2.0 is an upgrade to the Ethereum blockchain, designed to lower gas fees and increase transaction times. Among other changes, the migration will change Ethereum from a Proof of Work to a Proof of Stake blockchain. 

It’s currently estimated that the migration to Ethereum 2.0 will be completed sometime in 2022. 

However, Phase 0 of Ethereum 2.0 is already live. Currently, validators have the ability to stake their Ethereum on the Beacon chain and earn rewards. However, staked Ethereum and associated rewards cannot be transferred or withdrawn until the migration is complete. 

Is converting ETH to ETH 2.0 a taxable event? 

Because Ethereum 2.0 will be completely replacing Ethereum over time, it’s reasonable to assume 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 in their 2019 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 (when holders of Bitcoin received Bitcoin cash). 

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’.

What taxes will I pay when I sell Ethereum 2.0? 

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 gain tax event where you will realize a gain or loss depending on the market price of ETH 2.0 at the time of disposal.

ETH 2.0 taxes

Is staking ETH 2.0 a taxable event?

As discussed in our crypto mining and staking tax guide, crypto that is earned from staking is generally treated as income equal to its 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. 

At this time, this is a grey area in the tax code. There is no clear guidance from the IRS or other tax authorities on this matter. As a result, some investors are taking a conservative approach to tax reporting, while others are taking a more aggressive approach. 

The conservative approach is to report ETH 2.0 staking rewards as income at the time your coins are received, even if you can’t access it. 

The aggressive approach is to report ETH 2.0 rewards as non-taxable, since you do not have dominion and control over your coins. In this case, you will not report your coins as income until you have the ability to freely withdraw and trade them. 

Are your ETH 2.0 staking rewards taxed when you sell?

Regardless of which method you choose to report your staked ETH rewards, your cost basis will be equal to the fair market value of your coins at the time you recognize income. 

That means that when you sell your staking rewards or trade it for another cryptocurrency, you realize a capital gain or loss based on how the asset has fluctuated in value since you recognized the income. 

ETH 2 tax example

For a complete overview of how cryptocurrency taxes work, check out our Ultimate Crypto Tax Guide.

How crypto tax software can help 

Cryptocurrency tax software like CoinLedger can be used to automate the tax reporting for ETH 2.0 staking and all of your other crypto transactions.

By integrating directly with the exchanges, blockchains, and protocols that you use, CoinLedger can generate your gains, losses, and income reports from your historical transactions with the click of a button.

Get started with a free account today. 

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