On June 28, 2024, the Department of the Treasury (the Treasury) and the Internal Revenue Service (the IRS) released final regulations (Final Regulations) relating to information reporting, determination of basis and gain or loss, and backup withholding regarding certain digital asset transactions and exchanges, which are intended to implement the changes in law enacted by the Infrastructure Investment and Jobs Act of 2021.1 The Final Regulations update the proposed regulations that were released on August 25, 2023 (Proposed Regulations). Our alert on the Proposed Regulations can be accessed here.
The Final Regulations are expected to take effect on September 7, 2024. A brief overview of the Final Regulations is given below.
Scope of Digital Asset Reporting Requirements
The Final Regulations clarify that U.S. dollars and convertible foreign currency that are issued by a government or a central bank, whether in physical or digital form, are treated as cash (and not as stablecoins or other digital assets), and that neither stablecoins nor nonfungible tokens (NFTs) will be excluded from the scope of digital assets for the purposes of Section 6045.2 However, the Final Regulations do provide relief from reporting requirements by prescribing an optional method of reporting that excludes non-designated sales of qualifying stablecoins from the reporting rules.3 This optional method of reporting includes an annual aggregate de minimis gross proceeds threshold4 for designated sales of qualifying stablecoins or transactions involving NFTs, below which no reporting is required, and aggregate reporting (instead of transactional reporting) for customers that have aggregate gross proceeds from designated sales of qualifying stablecoins or NFT transactions during the year in excess of the de minimis threshold. Although digital assets that exist within a closed loop or video game (or video game network) are not excluded from the scope of digital assets, the disposition of such digital assets for different digital assets have been specifically excluded from reporting requirements if the disposed of digital assets cannot be transferred, exchanged, or otherwise used outside that system. Further, the Final Regulations streamline the reporting requirements with respect to dual classification digital assets, i.e., assets that qualify as digital assets and as commodities or securities.
The reporting requirements under the Final Regulations will only apply to custodial brokers and brokers acting as principals; reporting requirements applicable to other non-custodial brokers and decentralized exchanges (which do not take custody of the digital assets and may only provide facilitative services) will be covered by future regulations. Further, processors of digital asset payments (PDAPs) will only be required to report digital assets payments if such PDAPs receive possession of the digital assets that constitute the payment and could already obtain customer identification information from the buyer of digital assets to comply with anti-money laundering obligations. Real estate reporting persons that provide facilitative services and possess actual knowledge of the use of digital assets for payment for real estate will be required to comply with the reporting requirements. Any digital sales effected on behalf of a digital asset broker would be exempted from reporting.
Notice 2024-57 has been issued contemporaneously to provide that no reporting is required in respect of specific digital asset transactions such as staking, wrapping and unwrapping, short sales of digital assets, lending of digital asset and notional principal contract transactions, etc., until further notice. That Notice explicitly provides that it does not address the substantive U.S. federal income tax treatment of those transactions, and that no inference is intended in that regard.
Separate reporting of digital assets that are withheld by the broker in respect of transaction fees is not required; it will be attributed to the original transaction involving such digital assets.
Information Required to Be Reported
The Final Regulations remove the requirements to report the time of the transaction, the transaction ID and digital asset address relating to digital asset transactions. However, brokers are required to collect the transaction ID and digital asset address with respect to a digital sale and retain such information for seven years from the due date of the information return.
Reporting of Gross Proceeds and Adjusted Basis
Although no changes were made to the methods for reporting gross proceeds and basis provided under the Proposed Regulations, the Final Regulations revised the allocation of transactions costs where a digital asset is exchanged for a materially different digital asset, to provide that 100 percent of such costs should be allocated to the disposition. They also provide for specific ordering and identification rules for digital asset transactions.
The reporting requirements in respect of gross proceeds and basis will be implemented in a phased manner. Accordingly, gross proceeds are to be reported for digital asset transactions effected on or after January 1, 2025. Further, basis is to be reported for transactions effected on or after January 1, 2026, but only for digital assets that are acquired by, and held with, such broker on or after January 1, 2026, which eliminates the retroactive tracking that would have been required under the Proposed Regulations for digital assets acquired since January 1, 2023.
Further, Rev. Proc. 2024-28, which has been issued contemporaneously with the Final Regulations, generally permits taxpayers to rely on any reasonable allocation of units of unused basis to a wallet or account that holds the same number of remaining digital asset units based on the taxpayer’s records of such unused basis and remaining units, provided the allocation is a reasonable allocation (as provided in the revenue procedure) and must be made as of January 1, 2025.
Backup Withholding
Notice 2024-56, which was issued contemporaneously with the Final Regulations, provides transitional relief from deadlines for broker reporting requirements for sales effected during 2025 (as long as the broker makes good faith efforts to comply with those deadlines, and actually does file those returns within a reasonable period of time after the original due date for those returns) and backup withholding required under Section 3406 on all digital asset sales that occur during 2025 and certain digital asset sales that occur during 2026. In addition, this Notice provides that backup withholding will not apply to real estate reporting persons, sales effected by PDAPs, or sales of NFTs, and that no penalties would apply for a broker’s failure to withhold and pay any backup withholding tax that is caused by decreases in value of the digital assets received in a digital asset exchange (as long 24 percent5 of the digital assets received are immediately liquidated for cash and timely remitted).
Treatment of Certain Digital Assets as Commodities
The Final Regulations revise the definition of “commodities” (for purposes of the broker reporting rules) to include personal property that is traded through regulated futures contracts certified to the Commodity Futures Trading Commission. This change, along with some additional discussion in the Preamble to the Final Regulations, confirms that the Treasury and the IRS view digital assets that are the reference assets for such regulated futures contracts as commodities for purposes of these rules, and may support an inference that those digital assets generally ought to be treated as commodities for U.S. federal income tax purposes.6 This is also consistent with some outstanding IRS guidance, though that guidance did not specifically address digital assets.7
[1] The Final Regulations are scheduled to be published in the Federal Register on July 9, 2024.
[2] Unless otherwise specified, all Section references are to the Internal Revenue Code of 1986, as amended.
[3] Generally, “non-designated sales of qualifying stablecoins” are sales or other exchanges or dispositions of qualifying stablecoins in exchange for digital assets that are not qualifying stablecoins, and “designated sales of qualifying stablecoins” are all other sales or other exchanges or dispositions of qualifying stablecoins.
[4] The de minimis threshold prescribed for purposes of reporting of transactions involving stablecoins and NFTs are $10,000 and $600, respectively, which will be tested on the basis of each customer’s annual gross proceeds from transactions by the broker that would otherwise be required to report the transaction.
[5] If the backup withholding rate increases (e.g., due to the expiration of the reductions in tax rates that apply to individuals that were enacted as part of the 2017 tax legislation commonly referred to as the Tax Cuts and Jobs Act), it would be prudent to expect that there would be a corresponding increase in the percentage of digital assets that a broker is required to sell in order to avoid penalties for underwithholding due to decreases in value of digital assets received in a digital asset exchange.
[6] Final Regulations Section 1.6045-1(a)(19)(ii) appears intended to limit the inferences associated with the potential classification of digital assets as commodities, etc., for more general U.S. federal income tax purposes.
[7] See, e.g., Rev. Rul. 73-158, 1973-1 C.B. 337.
