It's not obvious that your interpretation is right. During the Bitcoin / Bitcoin Cash fork you received new BCH, especially if you "claimed" any UTXOs on the new chain.
"A holds 50 units of Crypto M, a cryptocurrency. On Date 1, the distributed ledger for Crypto M experiences a hard fork, resulting in the creation of Crypto N. Crypto N is not airdropped or otherwise transferred to an account owned or controlled by A."
So I interpret the line "Crypto N is not airdropped or otherwise transferred", too mean that there are no additional transactions that are recorded on the new blockchain N to give people additional coins, but previous state is maintained, as maintaining state is not a transfer.
An airdrop would have to be an actual state change, "recorded on the distributed ledger", that says "These people now receive 200 coins". In the case of a normal hardfork, there is no transfer that is "recorded on the distributed ledger".
I interpret that as meaning some sort of additional transaction, on the blockchain.
If you notice, in situation 2, the key line to look at is as follows:
"The airdrop of Crypto S is recorded on the distributed ledger on Date 2 at Time 1 ".
It specifically says that something must be recorded on the ledger.
The reason why situation 2 needs to be called out, specifically, would be in the case of a developer, hard forking a coin, and giving themselves a developer dividend, for example. It would make sense why the additional transactions, that are "recorded on the distributed ledger" would need to be taxed, as it is referring to additional coins being airdropped.
Edit:
Ah, you were also referring to this line here:
" A did not receive units of the new cryptocurrency, Crypto N, from the hard fork"
I'd interpret this the same way. The user did not receive any units of the cryptocurrency. They had it all along. It would take an actual state transfer for them to "receive" it.
It sounds weird to say, but basically, they had these coins already.
There does not need to be a transaction on any ledger for the receipt of the forked coins to be income.
What makes them income is that you received the forked coins, whether that fork is a true fork or just a new ledger that is otherwise identical to the old one. The IRS doesn't care about those technical details.
Situation 1 would apply if for example you choose not to receive the forked coins or if for some reason your exchange didn't recognize the fork and thus never credited any new fork coins to you.
Thanks for your read on it. Okay, now -- later you sell those Crypto N coins. What is your cost basis? You also sell the M coins, whats the cost basis there?
[FWIW, I think the way you're reading it has fewer absurd effects, I'm just struggling to convince myself that they actually meant what you're describing.]
Yeah. I'd encourage everyone to check with tax attorneys to be sure because klodolph's interpretation seems a bit suspect at first blush. Check with an attorney, or preferably two, just to be sure because the consequences for getting this wrong are nontrivial.
If you own bitcoin private keys, you already own coins on an infinite number of hard forks. You're just lacking a client to access them.