On Friday, June 28, Treasury and the IRS issued final regs under tax code section 6045 requiring custodial brokers to report dispositions of digital assets to the seller and the IRS on Form 1099-DA. This post represents my first attempt to summarize key points.
DEFI. Proposed regs issued in August 2023 created a new category of broker called "digital asset middleman" that appeared to include front ends, software wallets, RPC nodes, block builders, L2 sequencers, liquidity providers, and potentially many other market participants.
The final regs reserve on the definition of digital asset middleman, but the preamble says Treasury and the IRS "do not agree that non-custodial industry participants should not be treated as brokers" and intend to "expeditiously" issue final regs for noncustodial actors.
So, while LeXPunK Army, DeFi Education Fund, Blockchain Association, Coinbase, Bankless, and everyone who rallied for DeFi deserve major props, the battle isn't over, and it might be worth considering what further educational efforts can be done. (I have some ideas....)
STABLECOINS. The proposed regs required 1099s for all stablecoin dispositions, even if no gain or loss was recognized. To ease tax administration, the final regs offer brokers an alternative reporting method for most stablecoins.
Broadly, under the alt method, (1) exchanges of qualifying stables for non-stablecoin digital assets are not reported, and (2) exchanges of qualifying stables for other assets or services (incl other qualifying stables) are reported only if they exceed $10k/yr in aggregate.
Qualifying stables generally include crypto designed to track fiat if:
- Either (a) a mechanism prevents a > 3% depeg over any 10-day period in the calendar year or (b) regs require the issuer to redeem for fiat; and
- It is accepted as payment other than by the issuer.
NFTs. While the final regs continue to treat all NFTs as digital assets, they allow brokers to (1) not report a customer’s “specified NFT” sales if their annual gross proceeds do not exceed $600, and (2) otherwise report on an aggregated basis.
Specified NFTs are (1) indivisible and (2) unique “as determined by the inclusion in the digital asset itself of a unique digital identifier, other than a digital asset address.” These requirements seem to exclude semi-fungibles, ERC-404s, and possibly BTC inscriptions.
Notice 2024-56, issued with the final regs, also provides that, pending further guidance, brokers don't have to "backup withhold" when a customer's sale proceeds are a specified NFT. Backup withholding applies to taxpayers who fail to provide their tax form (W-9 or W-8).
DUAL CLASSIFICATION ASSETS. When a sale is reportable under both 1099-DA and 1099-B (e.g., tokenized stocks/bonds), 1099-DA generally trumps, except for: (1) US money market funds, (2) "1256 contracts" (e.g., futures contracts), and (3) "limited-access regulated networks."
The "limited-access regulated network" (LARN) exception generally is intended to avoid 1099-DA reporting caused solely because blockchain tech is used to facilitate the processing, clearing, or settlement of orders between regulated financial entities.
Generally, LARNs are permissioned networks for clearing/settlement that either:
- Give access only to regulated institutions;
- Are provided by a clearing agency; or
- Are controlled by a regulated institution and accessible only by it and its affiliates.
PROCESSORS OF DIGITAL ASSET PAYMENTS. PDAPs receive digital assets from payers and transfer value to payees (e.g., merchants).
The final regs generally require 1099-DAs by PDAPs only if they already have an agreement with the payer that allows AML-related ID verification.
Notice 2024-56 also generally exempts PDAPs from having to backup withhold pending further guidance, since PDAPs typically do not take custody of the goods or other assets acquired by the payer and thus would not have anything from which to withhold.
INFO REPORTED. The regs generally require reporting of gross proceeds for DA txns effected after 2024 and basis for DA txns effected after 2025. Basis reporting applies only for assets acquired through, and held with, the broker after 2025 (not 2022 as under the prop regs).
The final regs remove the proposed regs’ requirement to report txn time, txn ID, and customer’s blockchain address, but require brokers to retain txn ID and blockchain address for 7 years. Notice 2024-56 provides that brokers are not required to backup withhold on digital asset sales in 2025.
EXCLUDED TXNS. The final regs require brokers to report digital asset sales without defining sales. The substantive treatment of many crypto txns remains unclear. Notice 2024-57, issued with the regs, exempts some txns from reporting pending further study.
Generally, those excluded txns are:
- Wrapping/unwrapping;
- Liquidity provision;
- Consensus layer and liquid staking;
- Lending where the borrower has an "obligation" to return identical assets;
- Short selling; and
- Notional principal contracts.
MULTIPLE LOTS. Taxpayers who acquire a token at different prices, then sell less than all they hold, need rules to determine which “lot” they sold. The final regs generally treat a taxpayer as selling the first lot they acquired to the extent held in the selling wallet.
Alternatively, taxpayers can “specifically identify” which lot they sold (also only from the lots actually held in the selling wallet) by making a notation in their books and records before the time of sale. Because brokers might not always know when a taxpayer acquired which lots, the regs let brokers rely on taxpayer-provided information or alternatively apply default rules for reporting (but those rules don’t change the substantive tax result).
Revenue Procedure 2024-28, issued with the final regs, provides transitional rules for taxpayers who previously applied a multi-wallet approach to determining lots sold. Perhaps the subject of a future thread....
TRANSACTION COSTS. For determining basis and amount realized, the final regs generally treat gas fees or other txn costs:
- As an increase of the taxpayer's basis in the acquired assets in a cash-for-crypto txn; and
- Otherwise, as a reduction of amount realized.
CONCLUSION. The final regs improve a lot on the proposed regs. That said, they're enormously complicated and contain several traps for the unwary (like per-wallet lot determination). They'll take some time to fully digest.
We'll also have to see what happens with DeFi.
You can find the regs and related guidance at the link below. Let me know if you think I missed anything important or got anything wrong.
Treasury, IRS issue final regulations requiring broker reporting of sales and exchanges of digital assets that are subject to tax under current law, additional guidance to provide penalty relief, address information reporting and other technical issues
IR-2024-178, June 28, 2024 - The U.S. Department of the Treasury and the Internal Revenue Service today issued final regulations requiring custodial brokers to report sales and exchanges of digital assets, including cryptocurrency.
