16 July 2024 Treasury and IRS release final digital asset broker reporting regulations and certain transition relief
On July 9, 2024, the Treasury Department and the IRS published in the Federal Register TD 10000 (Final Regulations) on the information reporting of sales of digital assets. The IRS also released Notice 2024-56 and Notice 2024-57, providing transitional relief for digital asset brokers, and Revenue Procedure 2024-28, with guidance for taxpayers on allocating basis among digital asset wallets and accounts. At a combined total of more than 400 pages, this guidance package represents the most significant binding guidance that the IRS has issued to date on digital assets. After considering more than 44,000 written comments on the proposed regulations issued in August 2023 (see Tax Alert 2023-1513), the Final Regulations adopt the proposed regulations with numerous changes, including many exceptions and limitations that should make the information reporting regime easier to administer. That being said, digital asset brokers, as well as traditional brokers intending to use blockchain technology, will still face a significant challenge in implementing these rules. In addition, traditional brokers offering access to exchange-traded products that reference digital assets also need to be prepared to report on new Form 1099-DA. The Final Regulations are generally effective September 9, 2024. However, the applicability date for most of the changes to the proposed regulations, including the main regulation concerning digital asset reporting (Treas. Reg. Section 1.6045-1), is January 1, 2025. Sales on and after that date are reportable on the Forms 1099-DA, which are due to be filed in early 2026. Under Notice 2024-56, no penalties apply to brokers that make "good faith" efforts to comply with information reporting requirements for sales effected during 2025 but do not file on time. Good-faith efforts do not include filing returns or furnishing payee statements after the later of (1) the date that the IRS first contacts the broker about examining that broker, or (2) one year after the original due date for filing those returns. As in the proposed regulations, reporting for 2025 will not require reporting a customer's cost basis in a digital asset. That requirement begins for certain sales occurring on or after January 1, 2026, for digital assets acquired on or after that date. Unlike the proposed regulations, the Final Regulations do not require reporting basis for positions acquired before cost-basis reporting goes into effect. No guidance addresses broker-to-broker reporting for transfers of digital assets. Accordingly, cost-basis reporting is limited to sales of digital assets that were acquired, held until sale, and then sold by the customer within the same custodial broker. In addition, under Notice 2024-56, no backup withholding applies on sales during 2025; for sales during 2026, a broker is not required to backup withhold on a digital asset sale, even if it does not receive a Form W-9 from its customer, if the account was opened with the broker before January 1, 2026, and the broker uses the IRS TIN-matching service to verify the customer's TIN. The Final Regulations do not narrow the scope of digital assets subject to reporting as requested in industry comments. Under the Final Regulations, a digital asset includes any digital representation of value that is recorded on a cryptographically secured distributed ledger (or any similar technology), which includes cryptocurrencies like bitcoin and ether, stablecoins, and non-fungible tokens (NFTs). Further, a digital asset sale is reportable regardless of whether it is recorded on the blockchain, meaning that such tokens are digital assets subject to reporting, even if an exchange keeps its own ledger. Many commentors to the proposed regulations asked to exclude stablecoins pegged to a fiat currency due to the unlikeliness that such transactions will result in gain or loss. While stablecoins are still included in the definition of digital assets subject to reporting, the Final Regulations provide optional aggregate reporting and de minimis rules, discussed later. Similarly, many commentors asked to exclude NFTs because they might not be used for payment or investment purposes, such as those used as collectibles. Like stablecoins, NFTs remain within the Final Regulation's definition of digital assets subject to reporting, though the Final Regulations provide optional aggregate reporting and de minimis rules, discussed later. The proposed regulations requested comments on excluding digital assets that exist only in a closed system and cannot be sold or exchanged outside that system for fiat currency as well as those existing as part of a distributed ledger technology for ordinary commercial purposes. Treasury and the IRS noted that it was difficult to draft an appropriate exclusion in the definition of digital asset and instead opted to address the exclusion by adding transactions involving closed-loop digital assets to the list of excepted sales that are not subject to reporting. The Final Regulations instruct that dual classification assets such as tokenized securities or commodities are reportable on Form 1099-DA and do not require reporting on Form 1099-B. A tokenized security is defined as a dual classification asset that:
To address the differences in basis-reporting requirements and transfer-statement requirements for securities and commodities as compared to digital assets, the Final Regulations take a hybrid approach requiring brokers to apply the digital asset reporting rules, the wash sale rules and other rules that apply to basis adjustments for securities and options. The specific reporting requirements that apply to dual classification assets (meeting all applicable definitions) generally include the following:
Under the Final Regulations, brokers include custodial digital asset trading platforms, digital asset hosted wallet providers, digital asset kiosk owners and digital asset issuers that regularly offer to redeem those digital assets. The proposed regulations also included in the definition of broker non-custodial digital asset trading platforms (i.e., decentralized exchanges) and unhosted digital asset wallet providers. The Final Regulations reserve on including as brokers those industry participants that do not take possession of a customer's digital assets while Treasury and the IRS continue to study the issues around including such participants within the definition of broker. The final regulations provide a limited multiple broker rule to address industry's concerns that taxpayers would have received multiple Forms 1099-DA for the same transaction under the proposed regulations. If more than one broker effects a sale of a digital asset on behalf of a customer, the broker responsible for first crediting the gross proceeds on the sale to the customer's wallet or account is required to report the sale. The relief from reporting is for the broker that did not first credit the gross proceeds of a sale to a customer's wallet or account if that broker obtains a certification before the sale that the other broker is a US digital asset broker. The relief is limited to when amounts are credited through US digital asset brokers since only US digital asset brokers have a reporting requirement under the Final Regulations. The status declared by the US digital asset broker is exempt recipient status as described later. The Final Regulations continue to define broker to include persons that provide for or facilitate accepting digital assets in consideration for property as well as persons that facilitate real estate transactions in which digital assets are paid by the buyer in full or partial consideration for the real estate. The Final Regulations made several changes to the requirements for processors of digital asset payments (PDAPs). The definition of broker includes persons that facilitate payments from one party to another by receiving digital assets and paying those assets, cash or different digital assets to a second party, such as a merchant of goods or services. A PDAP effects a sale, and therefore has an obligation to report, if the PDAP knows or ordinarily would know both the nature of the transaction (to determine if it is a reportable transaction) and the gross proceeds from the transaction. As discussed later, the broker definition also includes third-party settlement organizations and payment card issuers that facilitate or make payments in digital assets. For reporting purposes, however, the Final Regulations limit customers of PDAP to those persons that have an agreement or other arrangement with the buyer and the arrangement provides that the PDAP may verify such person's identity or has an obligation to verify under anti-money laundering (AML) requirements. The Final Regulations maintain the basic definition of sales of digital assets, including a sale for cash and an exchange of a digital asset for another type of digital asset, securities, commodities, real property or certain services. However, certain exceptions have been strengthened, made more explicit or added in response to comments. "Excepted sales" that do not need to be reported include:
In addition, Notice 2024-57 removes certain common types of transfers of digital assets from the scope of reporting so that Treasury and the IRS can study them further. The Final Regulations make several changes to the types of information to be reported. Perhaps the most important change is that brokers are not required to report (1) the transaction identification number or hash of a sale or the digital wallet address from which an asset was transferred in connection with the sale, and (2) are not required to report that information, as well as date, time and number of units, for transfers of digital assets into a hosted wallet. Brokers are required, however, to collect transaction IDs and wallet addresses of these transfers and maintain their own records of this data for at least seven years after the due date of the relevant information return so that the IRS may request that information if it becomes relevant to an examination of a taxpayer. For transfers before the applicability date of the Final Regulations, the Preamble says taxpayers must preserve any records of the data "retained in the ordinary course of business." EY observes: The main objection to gathering this information has been that it is extremely sensitive and could be exploited by thieves and other bad actors. While the Final Regulations eliminate the possibilities of eavesdropping on a transmission of the information to the IRS and stealing the information from the IRS, they still require brokers to store this information for considerably longer than would be required for typical business purposes, making brokers tempting targets for hackers and raising significant data security issues for them. Hosted wallet providers may face the additional challenge of matching transfers from a customer's wallets with sales by that customer that the broker reports, should the IRS request that information. In addition, the Final Regulations removed the requirement to report the time of day of a sale, in addition to the calendar date. Brokers will be able to determine when a year (or holding period) begins and ends based on "a consistent time zone" of their choosing. The Final Regulations maintain the requirement to identify the kind of consideration received by a seller, but the Preamble explains that the broker must identify only the general type of consideration, and not provide a description of the specific consideration the seller received. For example, if digital assets are exchanged for a vehicle, the broker would report that the consideration was "property." The Preamble suggests that this information will be used to flag potential valuation issues in noncash transactions. The Final Regulations do not adopt a general de minimis threshold below which individual sale transactions do not need to be reported but do specify three situations where they do not need to be reported: (1) transactions in "qualifying stablecoins," (2) sales of "specified nonfungible tokens" (SNFTs), and (3) transactions by a processor of digital asset payments (PDAP). For qualifying stablecoins and SNFTs, the broker may report transactions exceeding the de minimis threshold in the aggregate, rather than on a transaction-by-transaction basis.
Under the Final Regulations, brokers may forgo reporting up to $10,000 of "designated sales" of qualifying stablecoins per customer and may report designated sales greater than that amount on an aggregate basis, meaning that a single Form 1099-DA reporting the combined gross proceeds of all the customer's sales in that qualifying stablecoin is required for each different type of qualifying stablecoin that a customer disposes. The $10,000 threshold is determined on a per-customer, rather than per-account, basis. Activity in a joint account is counted against the customer whose name is on the Form 1099-DA for that account. Cost-basis reporting is not required for designated sales of qualifying stablecoins. The aggregate reporting method is optional, but brokers must choose whether to report using the optional method or the standard transactional reporting rules for all transactions of a particular customer for a particular year. The broker need not file an election; simply using the aggregate method is sufficient. A "designated sale" of a qualifying stablecoin means a sale other than in exchange for a digital asset that is not a qualifying stablecoin. For example, a purchase of bitcoin with a qualifying stablecoin would not be a designated sale of the stablecoin. Non-designated sales of qualifying stablecoins are not required to be reported at all, on the theory that the purchased digital asset will eventually result in a Form 1099-DA when sold. To the extent a qualifying stablecoin fails the stabilization mechanism test during a calendar year, and thus becomes reportable on a transactional basis with no de minimis exception, backup withholding is required. However, the Final Regulations give a broker 30 days after the first "non-qualifying event" with respect to a previously qualifying stablecoin to commence backup withholding on transactions in that de-pegged stablecoin. EY observes: A non-qualifying event is defined as occurring as soon as the digital asset fails to meet any of the previous three tests. Presumably, the results-focused test is not failed until the end of the 10-day period, during which it may return to within 3% of its peg. Accordingly, brokers choosing to apply aggregate reporting and backup withholding relief must keep a constant eye on qualifying stablecoins and have procedures in place to commence backup withholding by the end of the 30-day grace period, should a non-qualifying event occur. An SNFT means a digital asset that meets a two-part nonfungibility test and does not reference certain excluded property. The nonfungibility test is satisfied if the NFT (1) is indivisible without losing its intrinsic functions, and (2) includes as an inherent part a unique digital identifier that distinguishes the digital asset from all others. Excluded property means securities, commodities and other property reportable on Form 1099-B or any digital asset that does not meet the nonfungibility test. Accordingly, a digital asset that satisfies the nonfungibility test and references a work of art, sports memorabilia, music, film or fashion design would be an SNFT. Under the optional reporting method for SNFTs, no reporting on Form 1099-DA is required if the customer receives less than $600 of gross proceeds during a calendar year. In addition, if the customer receives $600 or more of gross proceeds during the calendar year from SNFTs, the gross proceeds can be reported on a single Form 1099-DA along with the number of SNFTs sold, and no cost-basis reporting is required. A broker using the optional SNFT method must also identify the extent to which the aggregate gross proceeds are attributable to the first sale of an SNFT by the creator or minter of the SNFT, to the extent the broker ordinarily would know it is a first sale (for example, if the broker provided services that enabled the minting or creation of the SNFT). Brokers are not required to seek out information regarding whether a sale is a first sale, but if a broker asks a customer if the sale is a first sale and the customer answers in the affirmative, the broker is required to treat the sale as a first sale. PDAP transactions (other than for qualifying stablecoins and SNFTs) qualify for a $600-per-customer-per-year exception to reporting. The qualifying stablecoin and SNFT rules also apply to PDAPs, further minimizing reporting. The Preamble gives an example of a PDAP that conducts $9,000 worth of sales in qualifying stablecoins and $500 in sales of other digital assets for a customer during a year and concludes that the PDAP would not need to report any of the transactions if it applies the qualifying stablecoin and PDAP de minimis rules together. According to the Preamble, Treasury and the IRS were wary of brokers structuring straight sales of digital assets as PDAP transactions in order to take advantage of the de minimis rules so the de minimis exception does not apply if a PDAP transaction also falls within the definition of a non-PDAP sale. Accordingly, a PDAP that acts as the customer's agent, exchanges the customer's digital assets for cash and then pays the cash to a merchant, must report the sale of the digital assets without regard to the PDAP de minimis rule. On the other hand, if the PDAP is the merchant's agent in the foregoing transaction, the de minimis rule would apply. PDAP transactions exceeding $600 that do not qualify for the other de minimis rules for qualifying stablecoins and SNFTs must be reported on a transactional basis. Unlike those other de minimis rules, there is no aggregate reporting option for PDAP transactions. As in the proposed regulations, the Final Regulations do not limit amounts realized on the sale/disposal of a digital asset to cash received by customers but also include the sum of the following: (1) the fair market value (FMV) of any property received (or, for a debt instrument, any debt issued in connection with the digital asset exchange, which is generally the issue price of the debt), and (2) the FMV of any services received. The gross proceeds from these amounts realized are then reduced by transaction costs. For Form 1099-DA reporting purposes, gross proceeds from the sale of a digital asset equals cash paid or credited to the customer plus the FMV of any property or services the customer receives (including services giving rise to digital asset transaction costs), reduced by the digital asset transaction costs. Transaction costs (amounts paid in cash or property, including digital assets, to effect a sale disposition or acquisition of a digital asset) associated with the disposition of a digital asset are generally allocable to the disposition. While the proposed regulations excepted digital assets that are exchanged for other digital assets differing materially in kind or extent (e.g., an exchange of bitcoin for ether) such that the transaction costs would be allocated 50% to the disposed assets and 50% to the acquired assets, the Final Regulations eliminate this exception and allocate 100% of the transaction costs to the disposition of the transferred digital asset. The Final Regulations create a special rule to address "cascading digital asset transaction costs," i.e., transaction costs imposed on dispositions of digital assets used to pay those costs. If a digital asset is exchanged for a different digital asset and a portion of the acquired digital assets are withheld to pay the transaction costs to effect the original exchange, then the total transaction costs paid by the customer to effect both the original exchange transaction and any dispositions of digital assets to pay such costs are allocable exclusively to the original transaction. For digital assets that are covered securities, the Final Regulations set forth, in both the substantive basis regulations as well as the broker reporting regulations, ordering rules for a broker to determine which units of the same digital asset should be treated as sold, disposed of, or transferred (and therefore, what the basis of that digital assets is) when the customer owns multiple units of that same digital asset and acquired them on different dates or at different prices (some of which may have been transferred to the broker). When a customer makes a specific and adequate identification (spec ID) to the broker of the digital assets to be sold, disposed of, or transferred, the broker must report basis and other information of the identified assets. The customer must provide the spec ID to the broker no later than the date and time of the sale. Spec ID is made by reference to any identifier, such as purchase date and time or purchase price, that the broker designates as sufficiently specific to identify the units sold, disposed of, or transferred. The Preamble notes that it is most appropriate for brokers to determine the forms by which a notification can or must be made, and that no prescribed rule addresses the form of the notification. The customer is responsible for maintaining records to substantiate the identification. Unlike the rules for securities, there is no requirement that the broker confirm the spec ID in writing. The Final Regulations add new provisions on the ordering rules. First, like the rules for securities, a customer may use a standing order or instruction to make an adequate identification. If a broker offers only one method by which a customer can make a spec ID, that method is treated as a standing order or instruction for the specific identification of the digital assets, and thus an adequate identification (unless the rule described next applies). The Final Regulations also provide a default specific identification rule for when digital assets are exchanged for different digital assets and the broker withholds units of the digital assets received in the exchange to pay the customer's transaction costs or to satisfy the broker's obligation to backup withhold. In this case, there is a deemed adequate identification so the withheld units when sold will be treated as coming from the units received regardless of any other adequate identification. Because disposition of the units withheld should not give rise to gain or loss, the Final Regulations exempt the units withheld to pay the customer's transaction costs from information reporting. Units withheld to satisfy a broker's backup withholding obligation are exempt from reporting only if the broker sells the withheld units for cash immediately after the underlying sale. EY observes: The Final Regulations and Notice 2024-56 use the word "immediately," but it is not clear how much leeway brokers have. In the context of backup withholding on an exchange of one digital asset for another digital asset before the end of 2026, Notice 2024-56 states that "a broker that systemically liquidates the received digital assets when received as part of its process to perform the underlying sale transaction will be treated as immediately liquidating the received digital assets." This safe harbor does not appear in the Final Regulations. If the customer did not make a timely spec ID, and if the broker does not have adequate transfer-in date records (for example, they are destroyed) and does not have or take into account customer-provided acquisition information (discussed later), the broker must first report the sale, disposition or transfer of units that were not acquired by the broker for the customer. Next, the broker must apply the first-in-first-out (FIFO) cost-basis-selection method. This means the units of the digital asset sold, disposed of, or transferred are the earliest units of that type of digital asset acquired by the customer. If the broker does not have or take into account customer-provided acquisition information for digital assets transferred to the broker, it must treat the transferred-in units as acquired as of the date and time of the transfer. A broker may take into account customer-provided acquisition information to identify which units were sold, disposed of, or transferred. Customer-provided acquisition information means reasonably reliable information, such as the date and time units were acquired, that the customer or its agent must provide to the broker by the date and time of a sale, disposition or transfer. Reasonably reliable information includes purchase or trade confirmations at other brokers or immutable data on a publicly distributed ledger. To alert customers and the IRS that some of the information on Form 1099-DA was provided by the customer, brokers must report whether they received customer-provided acquisition information from the customer or its agent (regardless of whether the information on the particular unit sold was derived from the broker's own records or from the customer or its agent). A broker that takes customer-provided acquisition information into account is deemed to have relied on this information in good faith for the purposes of information reporting penalties unless it neither knows nor has reason to know the information is incorrect. This penalty relief, however, does not apply to a broker that takes customer-provided acquisition information into account for purposes of voluntarily reporting a customer's basis. The proposed regulations would have required brokers to provide information about cost basis for positions acquired as early as January 1, 2023, for sales occurring on or after January 1, 2026. Treasury and the IRS received numerous comments that raised concerns with the January 1, 2023, date and the retroactive application of the regulations. The Final Regulations adopt the recommendation to align the date that a digital asset becomes a covered security to the January 1, 2026, applicability date for cost-basis reporting. EY observes: It is welcome news that brokers do not need to track and report cost basis for digital assets acquired before January 1, 2026. Many brokers do not have systems that allow customers to identify particular digital assets for sale or apply FIFO and accurately track the basis attributable to any digital assets remaining in the customer's account for purposes of reporting basis as of January 1, 2023. In the Preamble, Treasury and the IRS "strongly encourage" brokers to work with customers who are subject to the new ordering rules for transactions beginning on January 1, 2025, to facilitate transitioning to the new basis tracking rules to the extent possible. Although many comments recommended delaying the effective date for cost-basis reporting to beyond January 1, 2026, that applicability date was not delayed. The Preamble states, however, that the IRS intends to "work closely with stakeholders to ensure the smooth implementation of the basis reporting rules." In addition, as previously described, Notice 2024-56 states that no penalties will apply to brokers who make "good faith" efforts to comply with information reporting requirements for sales effected during 2025, although this exception does not apply if the IRS contacts the broker about examining the broker before the broker files, or if the broker files the information returns more than one year after the original due date. In the words of the Preamble, the IRS expects to mitigate penalties in the early stages of implementation "for all but particularly egregious cases involving intentionally disregarding the rules." 7. Exceptions to reporting sales effected by brokers on behalf of exempt foreign persons and non-US broker reporting The proposed regulations had different requirements for US brokers, controlled foreign corporations (CFCs) and foreign brokers. Different reporting, documentation and presumption rules generally applied based on the brokers' status and where the sale was effected. The Final Regulations make three key changes to these requirements. Reporting requirements under the Final Regulations are limited to US digital asset brokers, which are defined as: (1) persons that effect sales of digital assets on behalf of other persons, and (2) US payors or US middlemen (as defined under the IRC Section 6049 regulations) that are not a foreign branch or office or a territory financial institution. The Final Regulations include specific documentation and presumption-rule requirements for US digital asset brokers, and reserve guidance for CFC and foreign brokers. Treasury and the IRS noted in the Preamble that this primarily responds to comments that brokers located outside the United States may ultimately have overlapping reporting responsibilities under the Crypto Asset Reporting Framework (CARF). According to the Preamble, Treasury and the IRS intend to issue proposed regulations that would, "if finalized," implement CARF. The Preamble further notes that these regulations would apply to exchanges of information for the 2027 calendar year (to be reported in 2028). Presumably, the reserved sections for CFCs and foreign brokers would be updated to coordinate with any final regulations on CARF reporting. EY observes: Limiting the reporting requirements to US digital asset brokers is a significant update. This helps mitigate some of the practical concerns and challenges for foreign brokers, including determining whether a sale is deemed to be effected inside or outside the United States. Implementation of CARF (if proposed and finalized), however, will be a substantial change for brokers, requiring coordination across reporting regimes. The Final Regulations retain the exceptions to reporting provided under Treas. Reg. Section 1.6045-1(c)(3)(i) for exempt recipients, such as certain corporations, financial institutions, tax exempt organizations and governments. The Final Regulations extend the list of exempt recipients to include US digital asset brokers because they have reporting requirements under the Final Regulations (unlike non-US digital asset brokers). Because the current Form W-9 does not have a certification for a US digital asset broker, requestors of Forms W-9 may rely on a written statement. See the later discussion on Notice 2024-56 for further details. For foreign customers, the proposed regulations included "reason to know" checks with expanded indicators of US status, such as customer communications with the broker using a device that is associated with an IP address indicating a location within the United States. The Final Regulations do not include any of the proposed additional types of US indicia, and generally retain the categories of US indicia that historically applied to US securities brokers. Treasury and the IRS noted in the Preamble that they are considering whether additional US indicia types should be included in further guidance on foreign digital asset brokers. Like the proposed regulations, the Final Regulations include a transition rule for brokers collecting tax documentation from customers. A broker can treat a customer as an exempt foreign person for sales effected before January 1, 2027, if the following are all satisfied:
EY observes: This transition relief provides additional time for brokers to collect documentation from customers to establish foreign status. Brokers will need to timely review customer profiles (and related system information) to determine if the customer cannot be treated as foreign during the transition period. The Final Regulations reference "account opening files or other files pertaining to the account, including documentation collected for purposes of an AML program." Under the Final Regulations, a US digital asset broker can collect a substitute Form W-8 (that meets all applicable requirements under the Chapter 3 regulations) from customers. The Final Regulations do not allow a US digital asset broker to collect a Self-Certification (or comparable documentation to what can be collected for FATCA and CRS purposes), as this would primarily relate to foreign brokers. The proposed regulations defined a "hosted wallet," but did not include a specific definition of a "wallet." The Final Regulations define a wallet as " … a means of storing, electronically or otherwise, a user's private keys to digital assets held by or for the user." For practical purposes, digital assets are not "held" or stored in wallets. The definition of "held in a wallet or account" in the Final Regulations has been reworded and further clarified to incorporate this point. A digital asset is generally considered held in a wallet or account if it stores the private keys necessary to transfer control of the digital asset. Treasury and the IRS further noted in the Preamble that "wallet" and "account" are used synonymously. In addition to the rules for brokers, the Final Regulations include rules for investors to determine their tax liabilities and the basis of digital assets sold. The Final Regulations continue to treat an exchange of one digital asset for another digital asset differing materially in kind or extent as a realization event for the investor. The IRS did not, however, provide guidance on what is considered a material difference, characterizing the issue as a factual one not in scope of the Final Regulations. The Final Regulations abandon the idea of splitting the cost between two digital assets in exchange of one digital asset for a different digital asset and allocating 100% of the transaction costs to the disposed position. The Final Regulations treat certain "cascading" transaction costs as allocable exclusively to the disposition of digital assets in the original transaction. The rules for how investors account for these costs are the same as the rules for brokers. The Final Regulations generally follow the proposed regulations and the basis calculations regulations that exist under IRC Section 6045 for securities. When a digital asset is acquired for cash, basis in a digital asset is the cash paid by the customer and transaction costs related to the acquisition. When the digital asset is acquired for another digital asset, the basis is the FMV of the digital asset received at the time of acquisition and transaction costs related to the acquisition. The Final Regulations reference the wash sale rules under IRC Section 1091, which were not addressed in the proposed regulations. A broker must apply the wash sale rules if both the sale and purchase occur within the same account or wallet for a tokenized security that is also a "stock or security" under IRC Section 1091 and the transactions involve covered securities with the same CUSIP or other security identifier. Revenue Procedure 2024-28 provides a safe harbor method for taxpayers to allocate any unused basis among digital assets they own as of January 1, 2025. Subject to certain restrictions, a taxpayer may make any reasonable allocation of unused basis to a wallet or account that holds the same number of remaining digital asset units. The taxpayer can allocate basis to specifically identified units of digital assets or allocate on a "global" basis by devising a rule prescribing how basis will be allocated. The digital asset must be a capital asset in the hands of the taxpayer and the unused basis must have been originally attached to a digital asset that was a capital asset. Unused basis from a digital asset can only be allocated to a digital asset of the same type, and the reasonableness of the allocation for one type does not impact the reasonableness of allocations for other types. Taxpayers must maintain records showing the total number of remaining digital asset units in each wallet or account. Records must also include details about unused basis units including cost basis and acquisition date. Allocations under the global method must be described in the taxpayer's books and records by January 1, 2025. Other allocations must be done by the earlier of the first sale on or after January 1, 2025, of any digital assets included in the safe harbor, or the due date of the taxpayer's 2025 income tax return. Any allocation under the safe harbor must be treated as irrevocable by the taxpayer. EY observes: Revenue Procedure 2024-28 provides several examples to illustrate the application of the safe harbor in different scenarios. These include situations where the taxpayer holds digital assets in multiple wallets, makes specific unit allocations or global allocations based on the safe harbor and transfers digital asset units to another individual. The examples highlight the importance of maintaining records, completing allocations by specified dates and complying with IRS regulations. Although the examples provide guidance on basic scenarios, they do not clarify what kinds of records will be considered sufficient. The comments to the proposed regulations requested guidance on the tax treatment of specific digital asset transactions such as wrapping, burning, liquidity transactions, splitting or combining digital assets, and the character and source of revenue-sharing agreements. The Final Regulations, which provide general rules for gross proceeds and basis determination for digital assets, did not adopt these recommendations as they were not deemed the appropriate forum to address these issues. In Notice 2024-57, however, the IRS outlined temporary exceptions to reporting certain identified transactions. Notice 2024-57 is effective for identified transactions occurring on or after January 1, 2025, and delays information reporting for certain transactions until Treasury and the IRS issue further guidance. Brokers will not have to file information returns or furnish payee statements on digital asset sales and exchanges for the following six types of transactions:
The IRS will not impose penalties for failure to file correct information returns or failure to furnish correct payee statements for those identified transactions. The Final Regulations modify the existing rules for reporting real estate transactions, which are reportable on Form 1099-S, to require a real estate reporting person to report on digital assets received by sellers of real estate in real estate transactions. However, this is required only if the real estate reporting person has actual knowledge, or ordinarily would know, that digital assets were received by the seller. A real estate reporting person is considered to have such actual knowledge if the terms of the real estate contract provide for payment using digital assets. EY observes: In response to comments arguing that real estate reporting persons may have trouble valuing the assets involved in a real estate transaction, the Preamble notes that a real estate reporting person has several ways to ascertain the relevant values. For example, the value could be in the sale contract and shared to determine commissions and taxes due at closing. It also may be easy to determine if the digital asset being used to purchase the real estate tracks the US dollar or is otherwise widely traded. The real estate reporting person could ask the buyer and seller whether they agreed on the value of the digital assets paid. The Final Regulations acknowledge that the real estate reporting person may report the value as undeterminable if none of these methods proves successful. EY observes: An example in the Final Regulations illustrates that a real estate reporting person may need to report both (1) gross proceeds received by the real estate seller from the sale of real estate on Form 1099-S, and (2) gross proceeds paid to the real estate buyer for the sale of digital assets used to purchase the real estate on Form 1099-DA. Final regulations under IRC Sections 6045A and 6045B include limitations on transfer statement reporting and issuer reporting related to actions affecting basis of securities (i.e., Form 8937). This relief is temporary until Treasury and the IRS issue further guidance.
Brokers and issuers that are not required to perform this reporting (under the prior exceptions) are not subject to the applicable penalties if they voluntarily decide to provide transfer statements or post Form 8937. IRC Section 6050W generally requires Form 1099-K reporting by payment settlement entities on certain payments made on payment cards and third-party network transactions (for example, sales on a marketplace). The Final Regulations implement a tie-breaker rule between the applicability of IRC Section 6045 or IRC Section 6050W for certain types of cash payments for digital assets or payments of one digital asset in exchange for a different digital asset. Under the tie-breaker rule, Form 1099-DA reporting applies to transactions where a payor makes a payment using digital assets as part of a third-party network transaction involving the exchange of the payor's digital assets for goods or services and that payment constitutes a sale of digital assets by the payor. Also, when goods or services provided by a payee are digital assets, and the exchange is a sale of digital assets by the payee, the payment to the payee in settlement of that exchange is reportable on Form 1099-DA. Form 1099-K reporting, and not Form 1099-DA reporting, applies where the item sold is not in the form of digital assets.
As previously discussed, Treasury and the IRS reserved on treating decentralized exchanges and certain unhosted digital asset wallet providers as brokers. Since the tie-breaker rule only applies to payors that are defined as brokers under the Final Regulations, it will not apply to decentralized exchanges, unhosted digital asset wallet providers or any other industry participant not subject to the final regulations to the extent they already subject to reporting under IRC Section 6050W. The existing backup withholding rules generally treat any payment that a broker or barter exchange makes and reports under IRC Section 6045 as a reportable payment that is subject to backup withholding. The Final Regulations include digital asset transactions that are reportable under IRC Section 6045 in the scope of transactions subject to backup withholding. In response to numerous comments detailing the difficulties with backup withholding in the digital asset space, the IRS issued Notice 2024-56, which provides transition relief from liability for the payment of backup withholding and any related penalties. In particular, a sale of a digital asset effected by a broker in 2025 is not subject to backup withholding (or related penalties). A sale of a digital asset effected by a broker in 2026 is not subject to backup withholding (or related penalties) if the payee (1) opened its account with the broker before January 1, 2026, and (2) the broker submits the payee's name and TIN combination to the IRS TIN matching program and receives a response that the name and TIN combination matches the IRS's records. In addition, until further guidance is issued, backup withholding is not required on (1) a digital asset sale in return for an SNFT, (2) any digital asset for a real property sale effected by a real estate reporting person, and (3) any PDAP sale effected by a PDAP. Notice 2024-56 also provides transition relief for the amount of backup withholding required to be deposited and reported for digital asset sales effected before January 1, 2027. Specifically, backup withholding is limited to what the broker receives upon liquidation of 24% of the customer's received digital assets, even if that is less than 24% of the FMV of the customer's received digital assets at the time of the transaction giving rise to backup withholding, as long as the liquidation immediately follows the transaction giving rise to the backup withholding. For these purposes, a broker that systemically liquidates the received digital assets as part of the underlying sale transaction will be treated as immediately liquidating the received digital assets. This amount should be reported as federal tax withheld on Form 1099-DA and included on the broker's Form 945. If a broker follows this guidance for reporting and deposits, it will not be subject to penalties for any decrease in value between the time of the transaction giving rise to the backup withholding obligation and the time the broker liquidates 24% of the received digital assets. The Preamble addresses comments asking the IRS to clarify or modify the rules for backup withholding on non-cash proceeds. First, the Preamble notes that some digital assets allow for subdivision; in those cases, a payor can satisfy backup withholding obligations by liquidating a portion of those proceeds. Whether a broker can withhold from digital assets that are sold is a matter for brokers and customers to determine based on legal or other agreements. Treasury and the IRS are aware that brokers may shift the withholding liability risk associated with price volatility in digital assets; because that arrangement would be a commercial one between the customer and the broker, the Final Regulations do not address it. Finally, the Final Regulations do not provide an exception to backup withholding for sales of digital assets in exchange for illiquid property. EY observes: Brokers should consider reviewing and potentially updating account opening and other legal agreements with customers to address backup withholding when a customer account has no cash available to be withheld and deposited. In certain cases, Form 1099-DA reporting is not required because of a de minimis threshold. Specifically, reporting is not required for payment transaction sales or sales of SNFTs below the $600 threshold, or for designated sales of qualifying stablecoins below the $10,000 threshold. Even though these sales are not reportable, they are still "reportable payments" for purposes of backup withholding. EY observes: Typically, when a payment is not subject to information reporting, it is also not subject to backup withholding. This is not the case for sales that fall below the de minimis thresholds. Broker systems will need to be programmed to identify and backup withhold on these transactions even when no reporting is otherwise required. Moreover, when a broker applies backup withholding it appears that it should file Form 1099-DA, even for transactions under the de minimis thresholds. Cascading withholding. The Final Regulations add a limited backup withholding exception to prevent cascading withholding when digital assets are used to pay transaction costs. As discussed previously, the exception would exclude from backup withholding certain sales for cash of withheld digital assets, as those sales are not a reportable sale under the Final Regulations. Therefore, such a transaction would not be subject to backup withholding as it is not a reportable sale. Certain stablecoin transactions. A broker may take advantage of an optional reporting method for designated qualifying stablecoins. Under that method, non-designated sales of qualifying stablecoins are not subject to information reporting, and therefore not subject to backup withholding. The Final Regulations provide a grace period to address scenarios where a digital asset loses its peg during a calendar year and therefore does not satisfy the conditions required to be a qualified stablecoin. If a sale would have satisfied the definition of a non-designated sale of a qualifying stablecoin for a calendar year but for a non-qualifying event during that year, a broker is not required to backup withhold on a sale if it occurs no later than the end of the day that is 30 days after the first non-qualifying event (i.e., the first date during the calendar year on which the digital asset no longer satisfies one of the three conditions to be a qualifying stablecoin) for that digital asset during such year. Notices 2024-56 and 2024-57 provide certain relief (with additional considerations) for broker digital asset reporting. The Notices address a "good faith effort" period, relief from backup withholding and how to identify US digital asset brokers. Brokers that make a "good faith effort" to file Form 1099-DA with the IRS, and provide copies to customers, will not be subject to penalties related to sales of digital assets under IRC Sections 6721 (failure to file correct information returns with the IRS) and 6722 (failure to furnish correct payee statements) during 2025. Notice 2024-56 does not define a "good faith effort." A good faith effort does not include any reporting by the broker after the later of the date (1) the IRS first contacts the broker about an examination, or (2) one year after the original reporting due date. Backup withholding is generally required on US nonexempt recipient customers unless a valid TIN is provided in the manner required (i.e., certified on a Form W-9 for broker proceeds). Notice 2024-56 provides specific backup withholding relief based on timing and the fact pattern:
Notice 2024-56 also details how to calculate the backup withholding when a digital asset is sold for different digital assets (other than SNFTs, which are subject to the relief previously noted). For sales effected before January 1, 2027, the following calculation requirements apply:
US digital asset brokers (other than registered investment advisors) are not subject to Form 1099-DA reporting. Therefore, when multiple brokers are involved in a transaction, brokers will need to identify this exempt status to avoid unnecessary reporting (or potential withholding). The current Form W-9 (Rev. March 2024) does not include a checkbox (or similar indicator) that could be used to identify US digital asset broker status. Therefore, until an updated Form W-9 is released, a broker can rely on a "written statement" from another broker that it is a US digital asset broker (other than a registered investment advisor). The written statement:
EY observes: It appears that the written statement must reference that the broker meets the definition of a US digital asset broker (under the relevant regulation cite). Notice 2024-56 does not further define how the written statement can be "associated with the Form W-9." This could mean that writing in the relevant language in the "other" line in Box 3a (or in the margins of the Form W-9) will satisfy the requirement, but this is not referenced. This would be the second time in recent history that the IRS will be releasing an updated version of a Form W-9 that has limited applicability. Although it is too early to tell now, further clarification on acceptable revisions and substitute forms may be needed for brokers that are not (and will not be) involved in digital assets. Notice 2024-57 provides that brokers are not required to file information returns on Form 1099-DA for six transaction types involving digital assets. Notice 2024-57 emphasizes that the guidance only relates to broker reporting requirements under IRC Section 6045 and does not address how a transaction should otherwise be treated for other US federal tax purposes. Notice 2024-57 also provides that the descriptions of each transaction only relate to the application of the IRC Section 6045 broker reporting requirements and does not address whether the transaction is (or is not) a sale of a digital asset.
Notice 2024-57 provides language throughout that it does not affect whether certain events associated with these transactions (for example, the receipt of staking rewards or airdrops) should be treated as subject to Form 1099 reporting "under another Code section as rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, interest, or other fixed or determinable income." Persons involved in any of these transactions should review and evaluate whether parts of these transactions may be subject to different Form 1099 reporting requirements, for example, Form 1099-MISC. The timeline laid out by the Final Regulations is ambitious. The chart below shows the effective dates for each stage of compliance. Brokers should begin familiarizing themselves with the process now.
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