Cryptocurrency airdrops — when a project sends out free tokens to early backers and supporters to promote the continued growth of the project — are not entirely the free gifts they may seem. The tokens have multiple U.S. tax implications that may come as a surprise to the owner when they report their annual income. 

Airdrops are a small but substantial portion of the crypto ecosystem. In 2023, the total value of crypto airdrops at their all-time high (ATH) prices was $4.56 billion, which was 61% lower than the prior year, according to CoinGecko data. Layer 2 scaling solution Arbitrum last March had the largest airdrop of the year when calculated using the ATH token price of $1.69, distributing $2 billion of its native $ARB token. 

The U.S. treats the free airdrop tokens as income for tax purposes, similar to mining and staking rewards, said CoinLedger CEO David Kemmerer in a phone call with Unchained. 

“The amount of income you realize is the fair market value of the airdrop at the time you have ‘dominion and control’ over it,” said Kemmerer, using a tax term that means you have full possession and are able to buy or sell the token. This income is reported on Schedule 1 of the 1040 tax form for that year. 

There are occasions when an airdropped token hasn’t begun actively trading and doesn’t have a fair market value. The token holder would then report the income once a fair market value does become available, according to a CoinLedger blog post. 

Beyond Income Tax

The token holder is not just subject to U.S. income taxes, however. When you sell the tokens you also trigger a capital gains tax or loss in the tax year of the sale. The capital gains tax applies only to the difference in value between the initial airdrop and the sale price. 

“If you made a gain, the amount of tax you pay depends on the period you’ve held the asset and your annual income,” said Danny Talwar, head of tax at Koinly, in an email to Unchained.

You’ll pay up to 37% tax on short-term (when you hold the tokens for less than 12 months) capital gains on crypto income and between 0% to 20% tax on long-term (more than 12 months) capital gains.

“If you’ve made a loss, you can utilize these to offset any capital gains. This is a great way to save on taxes and often gets missed by investors.”

Read more: Why Both Gamers and Developers Prefer Play-to-Airdrop Over Play-to-Earn

While these taxes are U.S.-centric, most countries around the world have some form of income and capital gains taxes, said Kemmerer. Token holders should consult a tax adviser for specific reporting requirements.