Some cryptocurrencies operate by consensus amongst that cryptocurrency’s community. When a significant portion of the community want to do something different, they may create a ‘fork’ in the blockchain or change the protocol within that blockchain to accept or reject future transactions.
There are two types of forks: a soft fork and a hard fork.
The blockchain for the original and the new cryptocurrencies have a shared history up to the fork. If an individual held tokens of the cryptocurrency on the original blockchain they will, usually, hold an equal number of that cryptocurrency on both blockchains after the fork.
A soft fork updates the protocol and is intended to be adopted by all. During a soft fork, no new cryptocurrencies are created from the fork to go to a holder, as such the soft fork is not a taxable event.
A hard fork, however, can result in a new protocol that creates new cryptocurrencies. An example of a hard fork is when Bitcoin Cash (BCH) was created in 2017. This split in the Bitcoin blockchain, which allowed for a larger block size would not allow all future blocks to add to its blockchain. As such, when Bitcoin Cash went live, a new token (BCH) was created and anyone holding original Bitcoin (BTC) also received BCH tokens for the new fork.
In this example, under current IRS guidance the IRS would consider the BCH tokens received at the time of that fork, or any other cryptocurrencies received as a result of a hard fork to be taxable income equal to the fair market value of the token when it was received.