Feature Article
In 2021, Public Law 117-58, the Infrastructure Investment and Jobs Act, §80603, required brokers to report transactions involving digital assets similar to stocks. This includes information on sale price, cost basis, and purchase and sale dates. The broad reach of digital asset transactions necessitated tracking basis across various sources and methods, creating questions such as: Who needs to report? Who is considered a broker? Which digital assets are included?
The Infrastructure Act amended Internal Revenue Code (IRC) §6045 to expand the definition of “broker” and included “any digital asset” in the definition of a “specified security.” Consequently, corresponding code section adjustments were necessary. This led to the final regulations published by the Internal Revenue Service (IRS) on July 9, 2024, in Treasury Decision 10000 (TD 1000). These regulations require brokers to report sales of digital assets, including stablecoins and non-fungible tokens (NFTs), with exceptions for certain assets.
To understand the current state of digital asset taxation, we must go back to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312). This legislation mandated reporting cost basis for certain securities. Brokers were required to report the adjusted basis of securities sold by their clients, phased in starting with stocks acquired on or after January 1, 2011. Form 8949 was created to reconcile transactions provided on Form 1099-B, as well as other transactions not reported on Form 1099-B, which then flow through to Schedule D in summary form.
The Treasury Department and the IRS estimate between 13 million and 16 million customers will be impacted by these regulations, with a midpoint of 14.5 million. This estimate is based on the number of taxpayers who received at least one Form 1099 reporting digital assets activity in tax year 2021, plus the number of taxpayers who responded “yes” to the digital asset question on their Form 1040 for tax year 2021.i
Understanding brokers’ responsibilities is essential for tax professionals to ensure accurate tax returns, particularly in the absence of formal guidance on digital asset transactions. Tax professionals must clearly communicate to clients the necessary documents for reporting digital asset transactions. For instance, when dealing with stocks, a tax professional typically requests a 1099-B form. Similarly, for digital asset
transactions, a 1099-DA form will now be required, though additional forms may also be necessary. The 1099-DA form will be explained, including scenarios in which it is not required.
What Is a Digital Asset?
A digital asset is any digital representation of value recorded on a cryptographically secured distributed ledger (secured database that cannot be altered, changed, or deleted), regardless of whether each individual transaction is recorded on the ledger. This definition does not classify digital assets as securities, commodities, options, securities futures contracts, regulated futures contracts, or forward contracts for tax purposes.ii
Who Is a Broker?
According to these final regulations, a broker is broadly defined. It includes any person, US or foreign, who, in the ordinary course of trade or business during the calendar year, stands ready to affect sales for others. This includes issuers of debt obligations, corporations redeeming
their own stock, and persons redeeming digital assets they created or issued.iii
However, brokers do not include any of the following:
While tax professionals are generally not considered brokers, they will still have clients with digital assets. Additionally, there are exceptions to the reporting requirements for certain NFTs and stablecoins.
What Is a Qualifying Stablecoin or NFT?
A qualifying stablecoin is a digital asset that meets specific conditions throughout the calendar year. The digital asset tracks a single convertible currency issued by a government or central bank on a one-to-one basis. The asset’s value does not fluctuate by more than 3 percent over any consecutive 10-day period, or the issuer is required to redeem the asset on a one-to-one basis for the tracked currency. The digital asset must be generally accepted as payment by entities other than the issuer.v
Non-fungible tokens are digital assets that represent ownership of a unique digital item such as art, music, or videos on the blockchain. Specified NFTs are digital assets that cannot be subdivided into smaller units without losing their intrinsic value or function. They include a
unique identifier that distinguishes them from other digital assets and are not excluded property. Excluded properties are securities, commodities, regulated future contracts, or forward contracts.vi
Determining Gain or Loss
Reg. §1.1001-7, added by these regulations, establishes guidelines for determining the gain or loss from the sale, exchange, or other disposition of digital assets.
When digital assets are sold or otherwise disposed of, the amount realized must be calculated to determine any gain or loss. This calculation involves considering the total value received from the transaction, which includes cash, the fair market value (FMV) of any property, and the FMV of services received. From this total, the costs associated with the transaction, referred to as digital asset transaction costs, are subtracted to arrive at the amount realized.
Digital asset transaction costs encompass various expenses incurred during the sale or exchange, such as transaction fees, transfer taxes, and commissions. These costs must be allocated to the specific digital asset transactions they pertain to, reducing the total amount realized and, consequently, the taxable gain or loss.
For sales involving cash, the amount realized is simply the cash received minus the transaction costs. In cases where digital assets are exchanged for other property or services, the amount realized is the FMV of the received property or services, again reduced by any transaction costs. When digital assets are exchanged for other digital assets that differ materially in kind or extent, the FMV of the newly acquired digital asset is used to calculate the amount realized.
In instances where a debt instrument is issued in exchange for digital assets, the amount realized is determined based on the value of the debt instrument as specified by IRS rules. Also, if digital assets are used to pay for transaction costs (such as fees to process a transaction), the IRS considers this as selling those assets, which could lead to a gain or loss. The IRS calls these transaction fees paid with digital assets “cascading digital asset transaction costs.”
The IRS also provides guidance on determining the FMV of digital assets. Generally, the FMV is assessed at the time of the sale or exchange. However, if the FMV of the received property or services cannot be determined with reasonable accuracy, the value of the digital assets given up in the exchange is used instead. This ensures a consistent and fair method of valuation across different types of transactions.
Optional Reporting Methods for Stablecoins and NFTs
Due to comments seeking to exclude NFTs and stablecoins from the new reporting, the IRS established an alternative reporting method. Brokers can choose to use these optional reporting rules for some or all of their customers. They can switch the reporting method each year but must use the same method for each customer throughout the year. Instead of following the standard reporting rules, brokers can report the sales of qualifying stablecoins in aggregate. This means that if a broker’s customer’s total sales of qualifying stablecoins exceed $10,000 for the year, the broker must report each sale individually on Form 1099-DA. If the total sales do not exceed $10,000, the broker does not need to report:
The optional reporting threshold is lower for NFTs. If a customer’s aggregate gross proceeds from sales of specified NFTs exceed $600 for the year after deducting transaction costs, no reporting is required. If sales are more than $600, brokers report it on the Form 1099-DA. The report should include the following information:
By offering these optional reporting methods, the IRS provides brokers with flexibility in how they report transactions involving stablecoins and NFTs, potentially simplifying the reporting process for both brokers and taxpayers.
Where to Report?
Form 1099-DA: Digital Asset Proceeds from Broker Transactions
Information Required on Form 1099-DA (As of Draft August 8, 2024)
Reporting Timelines and Penalties
Exemptions from Reporting
Basis of Digital Assets
The basis of digital assets received in a purchase or exchange is generally equal to the cost at the time of the purchase or exchange, plus any allocable digital asset transaction costs.x
As long as a client has adequate records to identify when units of digital assets are sold, disposed of, or transferred, the specific identification method may be used. First-in-first out (FIFO) must be used if records are not sufficient. Using specific identification methods does not constitute a change in accounting method.xi
If a client has multiple wallets there is a multiwallet approach to basis allocations. Revenue Procedure 2024-28 permits a taxpayer to rely on any reasonable allocation of units of unused basis to wallets or accounts that hold the same number of remaining digital asset units based on the taxpayer’s records of unused basis and remaining units in those wallets or accounts.
Typical Client Situation
Q. If my client provides a 1099-DA is that all I need for digital asset transactions now?
A. No. Clients should be asked additional questions to determine what other information may be missing. Clients with transactions outside of a centralized US-based exchange may need to provide records of those additional transactions. Clients with a large number of transactions across multiple wallets and outside exchanges should use digital asset reconciliation software to reconcile their transactions. This software should provide a Form 8949 to add to the tax return and ensure that all transactions are accounted for.
Example: The client indicates he or she sold stock, bought and sold digital assets through a centralized exchange such as Coinbase, played some video games with digital assets that utilized multiple wallets and transactions within the game as well as some decentralized transactions in multiple wallets, and bought and sold a home with a gain exceeding the exclusion allowed for his or her filing status.
This client will likely need to present a Form 1099-B for stocks, a Form 1099-DA for his or her centralized exchange digital asset transactions, and a Form 1099-S and/or closing disclosure for both the sale and the purchase of the home that was sold. What form will he or she receive for the digital assets in the video game or his or her multiple wallets and decentralized exchanges? It is likely that he or she will not receive forms for these yet and will need to provide additional records. Depending on the number of transactions, it may be beneficial for the client to utilize third-party reconciliation software for digital assets. Notice 2024-57 states that until further guidance, the following transactions do not need to be furnished reporting statements:
The final regulations published in TD 10000 provide crucial guidance for reporting digital asset transactions. Tax professionals must stay informed about these changes to ensure accurate tax reporting for clients involved in digital asset transactions. While the new rules aim to simplify the process, additional forms and reconciliation software may still be necessary, especially for transactions outside centralized
exchanges.
i TD 10000, Special Analyses, II. Paperwork Reduction Act
ii Reg. §1.6045-1(a)(19)
iii Reg. §1.6045-1 (a)(1) Returns of information of brokers and barter exchanges
iv Reg. §1.6045-1(b)(2)
v Reg. §1.6045–1(d)(10)(ii)(A)
vi Reg. §1.6045–1(d)(10)(iv)
vii Reg. §1.6045–1(d)(10)(i)(C)
viii Reg. §1.6045–1(d)(10)(iii)(B)
ix Reg. §1.6045–1(d)(2)(ii)(B)
x Reg. §1.1012–1 (h) Determination of basis of digital assets
xi Reg. §1.1012–1 (j)(1-4)Sale, Disposition or transfer of digital assets