Introduction
On June 28, 2024, the Internal Revenue Service (“IRS”) released final regulations captioned Gross Proceeds and Basis Reporting by Brokers and Determination of Amount Realized and Basis for Digital Asset Transactions (the “Final Regs,” T.D. 10000).1 The related proposed regulations had been previously published on August 29, 2023 (the “Proposed Regs”).2
Developing and applying information reporting rules to sales of digital assets, although required by the Infrastructure Investment and Jobs Act enacted in 2021 (the “Infrastructure Act”),3 represented a daunting task for regulators for two primary reasons: (1) unlike pre-existing broker information reporting, the digital asset business remains nascent when compared to the pre-existing securities and commodities business; and (2) sales reporting and basis reporting requirements for digital assets were enacted simultaneously, whereas for other types of broker reportable securities, these requirements were enacted separately over 25 years apart.4 In addition, broker reporting potentially triggers backup tax withholding from sales, which raises additional compliance concerns for digital asset market participants.
In response to the Proposed Regs, the IRS received over 44,000 comments from practitioners, academics and advisers, various industry organizations, and digital asset market participants.5 Consideration of these comments by the IRS (and the U.S. Treasury Department) resulted in substantial revisions in the Final Regs that narrowed the Proposed Regs in certain important respects. However, certain other requested changes raised in comment letters were not made. This results in a “good news, bad news” situation for many digital asset market participants.
The Final Regs reserve on a variety of broker issues, including rules for non-U.S. brokers, rules for controlled foreign corporation (“CFC”) brokers, and rules for non-custodial brokers under the facilitative services rules related to digital asset middlemen. When added to other rules that the Proposed Regs indicated would need to be addressed in subsequent phases, the sum of these new reserved items and the previously indicated future phases of guidance leaves a lengthy “to-do” list for Treasury and the IRS. When this forthcoming guidance is ultimately finalized and released, it would not be surprising if digital asset businesses not affected by the Final Regs could be faced with new broker reporting-related challenges.
In addition, at the same time the Final Regs were released, the IRS also issued two related notices (Notices 2024-56 and -57) and a revenue procedure (Rev. Proc. 2024-28) that reserve on reporting sales or applying backup withholding in certain cases, provide limited transitional relief from backup withholding and permit “across account” specific identification of tax lots sold.6 Altogether, the Final Regs, the two Notices, and the Rev. Proc. as released amounted to over 400 pages of guidance.7 The sheer amount of guidance released by the IRS related to broker digital asset reporting (the Final Regs, the two Notices, and the Rev. Proc.) makes a thorough analysis challenging. Because our objective is to provide a useful general overview, certain aspects of the new guidance and related context will be referenced rather than fully explained.
New information return for digital asset information reporting—Form 1099-DA
On September 9, 2024, the IRS released an updated draft of the new Form 1099-DA and a first draft of related broker instructions. The updated draft form reflects certain updates in reporting provided by the Final Regs. The Final Regs are clear that reportable digital asset sales conducted by brokers will be reported under their own separate rules and on a new information return form (Form 1099-DA). Practitioners, taxpayers, and others need a final version of the form and related instructions in order to properly report the sales of digital assets.8 The final version of Form 1099-DA will be of critical importance to brokers as they prepare to report required sales of digital assets occurring in the calendar year 2025 and beyond. Due to the prevalence today of electronic filing of tax forms (including information returns), additional guidance on e-filing is also needed.
Phasing of IRS guidance and new aspects of the Final Regs that are reserved
Like the Proposed Regs, the Final Regs do not generally require transfer reporting between brokers (related to the transfer of a customer’s covered securities) in connection with digital asset broker information reporting under Code Sec. 6045A. The preamble to the Proposed Regs had indicated that IRS guidance would be phased and that rules for transfer reporting under Code Sec. 6045A would be promulgated as part of a subsequent phase.9
A broker must generally take into account all information reported to it on a transfer statement (other than the tax classification of the security) and all information reported to it on an issuer statement (unless the statement is incomplete or the broker has actual knowledge that it is incorrect) in reporting sales to the IRS and to customers—however, these requirements apply only to covered securities (Reg. §1.6045-1(d)(2)(iv)(A)). Notably, the definition of a covered digital asset under the Final Regs is comparatively narrow and does not include digital assets transferred into a customer’s account with a broker. Under the Final Regs, it only includes digital assets that were acquired in a customer’s account (as opposed to securities transferred into the customer’s account) (Reg. §1.6045-1(a)(15)(i)(J)).
The preamble to the Proposed Regs had indicated that challenges related to so-called “dual classification assets” (assets considered both digital assets and another type of security under the broker reporting rules) made the finalization of guidance regarding issuer reporting challenging. In a departure from the Proposed Regs, for those covered digital assets constituting tokenized securities (the Proposed Regs did not include any special rules for tokenized securities), issuer statements are generally required to be issued (Reg. §1.6045A-1(a)(6)). For digital assets that are not tokenized securities, an issuer may (but is not required to) report organizational actions on an issuer statement (within the meaning of Code Sec. 6045B). If it does, it is afforded penalty relief for any applicable penalties under Code Secs. 6721 and 6722. However, such voluntary reporting may be unlikely due to not only the cost of preparing such statements but also potential penalty risks related to filing and signing unnecessary returns.
Outside of issuer statement reported information, a broker cannot rely on information provided by a customer or a third party in reporting the sale of covered digital assets (Reg. §1.6045-1(d)(2)(iv)(B)). This is in contrast to existing rules providing potential penalty relief in connection with such reliance for other types of covered securities. Brokers may, however, take customer-provided acquisition information into account for purposes of identifying which units are sold, disposed of, or transferred (Reg. §1.6045-1(d)(2)(ii)(B)(4)). The inability to make basis adjustments to covered digital assets based on customer or third-party information without potential penalty risk may create comparative reporting challenges between covered digital assets and other covered and noncovered securities.10 Note that this limitation only applies to covered digital assets. This limitation, coupled with the narrow definition of a covered digital assets set forth in Reg. §1.6045-1(a)(15)(J), could potentially allow the conversion of covered digital assets into noncovered digital assets by simply transferring them to a different account.
Key effective and applicability dates
The Final Regs are effective on September 9, 2024.11 The rules of the Final Regs are generally applicable to sales of digital assets on or after January 1, 2025.12 However, certain rules within the Final Regs are delayed by one year, such as the reporting of cost basis information related to sales of covered digital assets and the updated reporting rules related to certain real estate transactions. The applicability of certain digital asset-related conforming updates to the backup withholding rules of Code Sec. 3406 (under Reg. §§31.3406(g)-1 and -2) in the case of sales of digital assets are also delayed by one year. Similarly, Section 3.01 of related Notice 2024-56 delays the application of backup withholding in connection with sales of digital assets until at least January 1, 2026. The Final Regs additionally provide that certain regulatory changes related to penalty relief are also delayed until the related reporting rules become applicable. However, this delay has no adverse effect because the required reporting of sales of digital assets will not occur until on or after January 1, 2026.
Overview of the rules affected by the final regulations
The Final Regs include amendments to various interrelated tax and information reporting rules regarding sales of digital assets impacting various persons.
The Final Regs:
- amend certain rules that directly affect taxpayers that sell digital assets (Reg. §§1.1001-7 and 1.1012-1).
- amend certain rules that directly affect certain brokers (and certain other persons that are treated as brokers under the rules) that sell digital assets on behalf of customers (Reg. §1.6045-1).
- include new rules that result in certain sales reporting obligations for certain processors of digital asset payments (PDAPs) (these rules are scattered throughout Reg. §1.6045-1).
- amend rules that apply to real estate transaction reporting by certain persons (Reg. §1.6045-4).
- amend transfer reporting rules in connection with certain reportable sales (Reg. §1.6045A-1).
- amend rules related to issuer reporting of organizational actions affecting the cost basis of securities for purposes of broker basis reporting in connection with certain reportable sales (Reg. §1.6045B-1).
- amend rules related to payment card issuer and third-party settlement network organizations reporting certain payments (“card transaction reporting,” Reg. §1.6050W-1). These amendments address the overlap of broker reporting with card transaction reporting.
- modify the backup withholding rules to clarify that such rules apply to reportable sales of digital assets under the Final Regs and provide for de minimis reporting rules that can apply to sales of qualifying stablecoins, specified non-functional tokens (“NFTs”) and sales by PDAPs (Reg. §§31.3406-0, 31.3406(b)(3)-2, 31.3406(g)-1, and 31.3406(g)-2).
- add references to new Form 1099-DA in the penalty rules related to information return filing and associated payee statement reporting (Reg. §§1.6721-1 and 1.6722-1).
Guidance for digital asset sales by taxpayers
Computation of gain or loss on the sale of digital assets
Gain or loss on the sale of property is determined by com-paring the amount realized on the sale with the taxpayer’s adjusted basis in such property (Code Sec. 1001(a)).
The Final Regs add new Reg. §1.1001-7, setting forth the rules for the computation of the amount realized for purposes of determining gain or loss on the sale of digital assets. These rules broadly apply to taxpayers selling digital assets, except in the limited case of sales of certain dual classification assets that are not subject to reporting as digital assets (Reg. §1.1001-7(a)).
In general, these rules provide that a taxpayer’s computation of the amount realized on such sales is equal to the sum of any cash received, plus the fair market value of any property or the fair market value of services received, reduced by the amount of any digital asset transaction costs allocable to such sale (Reg. §1.1001-7(b)(1)(i)). Note, however, that if a debt instrument subject to Reg. §1.1001-1(g) is issued in the exchange, the issue price of the debt instrument should be used instead of its fair market value.
The rules then detail how they are applied for digital assets sold for cash, for services or certain property, and for other digital assets (Reg. §1.1001-7(b)(1)(iii)). The fair market value of digital assets sold is determined as of the date and the time of the sale (Reg. §1.1001-7(b)(3)). A special rule generally applies if the fair market value of property or services received cannot be determined with reasonable accuracy—in such cases, the fair market value of such property or services must be determined by reference to the fair market value (as of the date and time of such exchange) of the digital asset transferred (Reg. §1.1001-7(b)(4)).
Digital asset transaction costs
Digital asset transaction costs are defined for purposes of these rules as “amounts paid in cash or property (including digital assets) to effect the sale, disposition or acquisition of a digital asset,” including transaction fees, transfer taxes, and commissions (Reg. §1.1001-7(b)(2)(i)). Digital asset transaction costs are allocable as specifically set forth in the regulations and “any other allocation or specific assignment of digital asset transaction costs is disregarded” (Reg. §1.1001-7(b)(2)(ii)). In general, digital asset transaction costs paid in connection with the sale of digital assets are “allocable to the sale or disposition of the digital assets” (Reg. §1.1001-7(b)(2)(ii)(A)). However, so-called “cascading digital asset transaction costs” (as defined therein, these are essentially additional digital asset transaction costs indirectly related to the original sale) are “allocable exclusively to the disposition of digital assets in the original transaction” (Reg. §1.1001-7(b)(2)(ii)(B)).
Determination of basis for digital assets sold generally
The adjusted basis of digital assets sold is determined by reference to the rules of Code Sec. 1012 and other applicable rules of the Internal Revenue Code as specified (Code Sec. 1011).
The Final Regs amend the rules applicable to taxpayers related to the determination of basis under Code Sec. 1012 for digital assets (Reg. §§1.1012-1(h) and (j)).
The Final Regs generally provide that “the basis of digital assets received in a purchase or exchange is generally equal to the cost thereof at the date and time of the purchase or exchange, plus any allocable digital asset transaction costs as determined [under the regulations]” (Reg. §1.1012 1(h)(1)). New Reg. §1.1012-1(h)(1)(i)-(vi) set forth the rules for the determination of the initial basis of digital assets (other than in connection with certain dual classification assets not treated as digital assets under the broker reporting rules) received for cash, property other than digital assets, services, digital assets, certain debt instruments, and in transactions that are part gift and part sale.
As is the case with the provisions of the Final Regs regarding the determination of the amount realized on the sale of a digital asset, the basis rules include provisions related to the treatment of allocable digital asset transaction costs (Reg. §1.1012-1(h)(2)).
In general, the rules are similar to the rules for allocable digital asset transaction costs incurred in connection with the sales of digital assets (id). However, such allocable costs are generally added to the taxpayer’s basis in digital assets acquired (Reg. §1.1012-1(h)(2)(ii)(A)).
There is a special rule that allocates all digital asset transaction costs incurred on the exchange of a digital asset for another digital asset to the disposed digital asset (Reg. §1.1012-1(h)(2)(ii)(B)). This is a change from the rule of the Proposed Regs that would have allocated 50% of allocable digital asset transaction costs to the sale and the other 50% to the acquisition. Similar to the special rule for the allocation of cascading digital asset transaction costs in sales transactions, Reg. §1.1012-1(h)(2)(C) allocates all of such costs (along with any other digital asset transaction costs) to the disposition of digital assets in the original transaction.
In the case of the receipt of digital assets for property, the fair market value of the property used for purposes of determining the amount realized on the sale is used to determine the cost of the digital assets received (Reg. §1.1012-1(h)(3)). Generally, the cost of a digital asset received is determined at the date and time of the transaction (id). If the fair market value determined under this method cannot be determined with reasonable accuracy, it is determined based on the fair market value of the digital asset received (see cross reference to Reg. §1.1001-7(b)(4)).
Determining the basis of specific lots of digital assets sold
Rules governing the determination of basis of digital assets sold can be divided into rules applicable to digital assets held by taxpayers directly (in unhosted wallets) and rules applicable to digital assets held in the custody of brokers (Reg. §1.1012-1(j)(1)).
For digital assets held in unhosted wallets, when less than all of a particular digital asset held is sold, disposed of, or transferred, the basis and holding period of these digital assets can be determined by specific identification of the digital assets by the taxpayer (Reg. §1.1012 1(j)(1)). If such specific identification is not made, the digital assets sold, disposed of, or transferred are determined on a first-in, first-out (“FIFO”) basis, taking into account when the digital assets were first acquired by the taxpayer (not when they were transferred into the wallet by the taxpayer; id).
Specific identification requires that, no later than at the time and on the date of the sale, disposition, or transfer, the taxpayer must identify on its books and records the particular units (“lots”) sold, disposed of, or exchanged by reference to any identifier, such as purchase date and time or purchase price (Reg. §1.1012-1(j)(2)). The rules further provide that “[a] specific identification can be made only if adequate records are maintained for the unit of a specific digital asset not held in the custody of a broker to establish that a unit sold, disposed of, or transferred is removed from the wallet” (id).
If digital assets are held in the custody of a broker, different rules apply (Reg. §1.1012-1(j)(3)). In general, unless the customer adequately identifies which lots are sold, Reg. §1.1012-1(j)(3)(i) provides that the digital assets sold, disposed of, or transferred are determined on a FIFO basis taking into account when the digital assets held in the custody of the broker were first acquired by the taxpayer (unless the acquisition date is unknown, in which case the transferred in date should be used).
Alternatively, if multiple lots of the same digital asset are held by a broker for a customer, then the lots sold, disposed of, or transferred can be adequately identified by the taxpayer specifying to the broker (no later than the date and time of the sale, disposition, or transfer) the particular units sold, disposed of, or transferred by reference to any identifier, such as purchase date and time or purchase price (Reg. §1.1012-1(j)(3)(ii)).
The regulations further provide that the taxpayer is responsible for maintaining records substantiating such identification (id). Moreover, the rules provide that a so-called “standing order” identifying lots by a specified method of sale or instruction is permitted. The selection of basis averaging for covered securities (if permitted) constitutes an allowable standing order. And in the case of a broker that only allows a single method of lot relief, there is a deemed standing order for such method (id). Note that there is not a similar deemed standing order rule in connection with basis determinations for securities other than digital assets.
There is deemed identification for exchanges of digital assets for other digital assets where digital assets are withheld for payment of digital asset transaction costs or related backup withholding taxes (Reg. §1.1012-1(j)(iii)).
Finally, the rules clarify that a lot relief method is not a method of accounting for tax purposes, and further explicitly clarify that a change in lot relief method is not subject to the change in method of accounting rules of Code Secs. 446 and 481 (Reg. §1.1012-1(j)(iv)).
Applicability date for these rules
These rules are applicable to all acquisitions and dispositions (sales and exchanges under Code Sec. 1001) of digital assets that occur on or after January 1, 2025 (Regs. §§1.1001-7(c), 1.1012-1(h)(5) and (j)(6)).
Rev. Proc. 2024-28 and transitional relief for determining the basis of lots sold
In general, the Final Regs (consistent with the language of Code Sec. 1012(c)(1)), as applicable for digital assets sold, exchanged, or disposed on or after January 1, 2025, require that rules governing the basis of assets (including the lot relief rules such as FIFO, basis averaging (if applicable) and specific identification) are applied on an account-by-account basis.
Taxpayers noted that Virtual Currency FAQs posted by the IRS could have been interpreted as permitting “cross account” or multi-wallet selection of lots sold, disposed of, or exchanged (see background discussion in Rev. Proc. 2024-28, Section 2). Rev. Proc. 2024-28 provides transitional relief from the “account by account” rules of the Final Regs (and the Code) in connection with determining the basis of certain digital assets disposed if various requirements of the revenue procedure are satisfied.
As described in the background section of the revenue procedure, to the extent specified requirements of the procedure are satisfied, under this transitional relief the revenue procedure “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” (id).
Details of the available transitional relief
This transitional reporting method for unused basis in digital assets held is only available if various requirements are met. It is not available if allocations of basis are currently under review by a U.S. court, the IRS Office of Appeals, or are being reviewed in an IRS examination (Rev. Proc. 2024-28, Sec. 4.01(3)).
The rules of the revenue procedure apply separately to different types of digital assets, including a determination of whether its various requirements can be satisfied, and may be available for sales of some digital assets and not to others (Rev. Proc. 2024-28, Secs. 4.01(4) and (5)).
The allocation method must be any reasonable method (Rev. Proc. 2024-28, Sec. 5.01) and the following additional requirements must be met per Rev. Proc. 2024-28, Sec. 4.02:
- Each remaining digital asset unit must be a capital asset in the hands of the taxpayer. See Code Sec. 1221.
- Each unit of unused basis must have been originally attached to a digital asset unit that was a capital asset in the hands of a taxpayer.
- The digital asset unit from which the unused basis is derived and the remaining digital asset unit must be the same type of digital asset.
- The taxpayer must be able to identify and maintain records sufficient to show the total number of remaining digital asset units in each of the wallets or accounts held by the taxpayer.
- The taxpayer must be able to identify and maintain records sufficient to show the number of units of unused basis, the original cost basis of each such unit of unused basis, and the acquisition date of the digital asset unit to which the unused basis was originally attached.
- A taxpayer must treat any allocation under the revenue procedure as irrevocable for all purposes of Code Sec. 1012.
Note that a taxpayer “must identify the remaining digital asset units and maintain records sufficient to show the units of unused basis ..,” “must complete the allocations of all units of unused basis to the same number of remaining digital asset units within all wallets or accounts held by the taxpayer …” by an applicable date on either a specified unit allocation or a global allocation basis (as defined in the Rev. Proc.), and must separately account for any acquisitions or transfers of digital assets held within the same wallet until the time the taxpayer has completed its allocations under the revenue procedure (Rev. Proc. 2024-28, Sec. 5.02). A method is analyzed for reasonableness separately for different types of digital assets and allocations of (or the re-use of ) previously identified and used basis in digital assets are (or is) not reasonable (Rev. Proc. 2024-28, Secs. 5.02(6) and (7)). Failure to comply with every applicable requirement of the revenue procedure means that the taxpayer cannot rely on its transitional relief (Rev. Proc. 2024-28, Sec. 5.03). Note that the revenue procedure provides an allowable method for allocating the remaining basis as of January 1, 2025, of digital assets but does not address the correctness of the taxpayer’s calculation of the amount of remaining basis (Rev. Proc. 2024-28, Sec. 5.04).
Revenue procedure effective date and applicable dates; transitional relief
Rev. Proc. 2024-28 is effective as of June 28, 2024. Note the dates referred to above regarding the digital assets it applies to and the deadlines on requirements specified above. Any permitted transitional allocations of unused basis only apply to digital assets acquired by or transferred to the taxpayer before January 1, 2025 (Rev. Proc. 202428, Section 4.01(2)).
Key new or expanded definitions related to digital asset broker reporting
Definition of digital asset Is broad and includes stablecoins and NFTs
The Final Regs explicitly define a digital asset for broker reporting as “any digital representation of value that is recorded on a cryptographically secured distributed ledger (or any similar technology) …” (Reg. §1.6045-1(a)(19)(i)). The preamble to the Final Regs makes it clear that this definition is intentionally broad and, in general, stablecoins and NFTs fall within this expansive definition.13 The Final Regs expressly provide that this broad definition is not intended to be determinative for purposes outside of information reporting (Reg. §1.6045-1(a)(19)(ii)). The definition of a digital asset, which generally includes stablecoins and NFTs, remains broad under the Final Regs, despite some of the comments received regarding the Proposed Regs (89 FR 56482-56483).
Definition of a dual classification asset
Because the Final Regs impose a separate reporting regime for digital assets (including reporting of sales on Form 1099-DA), brokers and taxpayers must determine how to report the sale of an asset that is simultaneously characterized as a digital asset and also an asset otherwise subject to existing broker sales reporting (such assets are referred to as “dual classification assets,” Reg. §1.6045-1(c)(8)(i)). The Final Regs address this by providing special reporting rules for such assets.
The Final Regs include a general rule that treats dual classification assets as digital assets that are subject to broker reporting, subject to certain important exceptions (Reg. §1.6045-1(c)(8)(i)).
Definition of tokenized securities
A subclass of dual classification assets as defined under the Final Regs are “tokenized securities” (Reg. §1.60451(c)(8)(i)(D)(1)). Due to the potential for heightened reporting obligations, brokers and taxpayers must deter mine if a dual classification asset that is characterized as a digital asset is a tokenized security. (Reg. §1.60451(c)(8)(i)(D)(3)).
Code Sec. 1256 contracts
If a dual classification asset is a Code Sec. 1256 contract, it is reported by brokers solely under the rules for Code Sec. 1256 contracts rather than the rules for digital assets (Reg. §1.6045-1(c)(8)(ii)).
Reporting for digital assets on a limited-access regulated network
A “limited-access regulated network” is defined as (a) a cryptographically secured distributed ledger, or network of interoperable cryptographically secured distributed ledgers, that provides clearance or settlement services and that provides access to only certain identified persons that are registered U.S. securities or futures dealers, common trust funds (as defined in Code Sec. 584) or certain specified financial institutions including a bank, mutual savings bank, savings and loan or building and loan association, co-op bank, credit union, etc.) or provides access to its participants by a clearing agency registered with the SEC or has received an exemption order as a clearing agency from the SEC, or (b) a cryptographically secured distributed ledger controlled by a single person described in section (6) through (11) of the exempt recipient rules of the broker reporting regs that permits the ledger to be used solely by itself and its affiliates (and does not provide access to the ledger to third parties or customers; Reg. §1.6045-1(c)(8)(iii)(B)).
If a dual classification asset is considered a digital asset solely because it is cleared or settled on a limited-access regulated network (as defined), the general rule does not apply and sales are reported by a broker only under the existing rules for assets other than digital assets (Reg. §1.6045-1(c)(8)(iii)(A)).
U.S. money market fund shares
If a dual classification asset is a U.S. money market fund that is permitted to hold itself out as such under SEC Rule 2a-7, then it is solely treated as a money market fund and not as a digital asset (Reg. §1.6045-1(c)(8)(iv)). Sales of such shares, regardless of their digital representation, remain exempt from broker reporting as provided in Reg. §1.6045-1(c)(3)(vi).
Digital assets held in trust on behalf of customers
The Final Regs clarify that unless the interests in a trust holding digital assets are themselves digital assets, sales of interests in such a trust are reported on Form 1099-B rather than as sales of digital assets reportable on Form 1099-DA (Ex. 20, Reg. §1.6045-1(b)(20)). In other words, the trust is not treated as a digital asset under the Final Regs merely because the assets underlying the trust are digital assets (89 FR at 56490).
Reg. §1.6045-1(d)(9) was also amended to clarify that if a widely held fixed investment trust (“WHFIT”) sells a digital asset, the WHFIT reports the sale under the WHFIT reporting rules (Reg. §1.671-5). If interests in the WHFIT are held by a securities broker on behalf of customers, such broker would report such sales to customers holding interests in the WHFIT unless a reporting exemption applies (89 FR at 56490). However, see the discussion below noting that certain sales of WHFIT assets may be exempt from WHFIT reporting.
Notice 2024-57 and exemptions from reporting certain transactions
Although the definition of a digital asset under the Final Regs is broad, Notice 2024-57 provides that certain types of digital asset transactions are currently exempt from reporting. The Treasury and the IRS have determined that the specific types of digital asset transactions identified below require further study in order to determine appropriate reporting and are therefore currently exempted from broker digital asset sales information reporting (Notice 2024-57, Sec. 3.01).
The Notice also clarifies that the summary descriptions of these currently exempted types of transactions are not intended to constitute or reflect “a substantive analysis for Federal income tax purposes of any of the identified transactions or their component steps, and no inference is intended as to how an identified transaction, or its component steps, is treated for substantive Federal income tax purposes” (id).
The types of digital asset transactions identified in the notice are exempt from broker information reporting and incorrect or absent returns and payee statements for sales involving these transactions are eligible for penalty relief under Code Secs. 6721 and 6722 (id).
The circulation and ownership of Bitcoin, Ethereum (or “Ether”), and many other digital assets are managed via distributed ledgers. A distributed ledger exists when multiple copies of the ledger are maintained and updated (typically publicly) by multiple participants. Distributed ledgers are a key element of public blockchains. Central to the dissemination of a distributed ledger is a consensus mechanism that is used to validate that the data on a particular public ledger is correct. Two different consensus mechanisms are primarily used today: proof of work and proof of stake.
Notice 2024-57 provides that staking transactions are not reportable sales for purposes of broker sales reporting (Notice 2024-57, Secs. 3.01 and 3.04). The Notice additionally exempts some transfer and redemption transactions described as “wrapping and unwrapping” transactions involving digital assets from certain types of broker information reporting (as defined therein; Notice 2024-57, Secs. 3.01 and 3.02). Liquidity provider transactions (as defined therein) are also exempt from broker sales reporting (Notice 2024-57, Secs. 3.01 and 3.03(1)). Furthermore, digital asset lending transactions, regardless of whether the taxpayer in question participates as a borrower or lender (“Type I” or “Type II” as defined in Notice 2024-57), are exempt from broker sales reporting under Notice 2024-57.
Note that these exemptions are expressly limited to broker sales reporting and generally do not restrict whether these or related transactions during the same time period “should be treated as otherwise subject to information reporting under another Code section as rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, interest, or other fixed or determinable income.” (Notice 2024-57, Sec. 3.02(2)).
Finally, Notice 2024-57 also provides an exemption from broker sales reporting for “the transfer of a digital asset as a payment under, or on sale of, assignment of, or similar transaction with respect to a notional principal contract” (Sec. 3.07). Also, if the notional principal contract is itself a digital asset, the termination of the contract is also exempt (id).
In addition to the exemptions provided by the Notice, the Final Regulations exempt certain specified transactions from broker sales reporting (Reg. §1.6045-1(c)(3)(ii), referred to in the Final Regulations as “Excepted Sales”). Importantly, Excepted Sales include sales of digital assets withheld by a broker to pay a customer’s digital asset trans action costs and sales undertaken immediately by a broker to satisfy a related backup withholding obligation (Reg. §1.6045-1(c)(3)(ii)(C) & (D)). Additionally, Excepted Sales also include certain dispositions in connection with loyalty programs, video games, inventory management, and goods or services coupons.
Effective date of the notice
The Notice is effective for the transactions identified therein that occur on or after January 1, 2025 (Sec. 4). This aligns with when the sales-related rules of the Final Regs apply.
Definition of a digital asset broker
A broker for purposes of the broker reporting rules is defined in Reg. §1.6045-1(a)(1). In general, it is a person who in the ordinary course of a trade or business stands ready to effect sales to be made by others (id). Under proposed rules that were different than those applicable with respect to securities brokers, U.S. and non-U.S. digital asset brokers (along with CFC digital asset brokers) would have been treated as digital asset brokers with potential sales reporting obligations. These rules were considered controversial in various respects, including the applicability of the Proposed Regs to non-U.S. digital asset brokers and CFC digital asset brokers.
On October 10, 2023 (shortly after the IRS had released the Proposed Regs), the Organization for Economic Co-operation and Development (“OECD”) finalized a new global tax transparency framework. It provides for the automatic exchange of tax information on transactions in crypto-assets in a standardized manner (the Crypto-Asset Reporting Framework (“CARF”)). This framework must be individually adopted by each country electing to apply the CARF. On October 11, 2023, it was announced that 48 nations had pledged to adopt and implement the CARF by 2027. The United States is an OECD participating nation and plans to implement the CARF (89 FR 56517). Comments had been raised that non-U.S. brokers participating in the exchange of tax information under the CARF should not be required to also report under separate broker information reporting rules or collect duplicative U.S. certifications from customers (89 FR 56517). It had also been commented that rules relating to reporting by non-U.S. brokers should be delayed until they are harmonized with the CARF and that a single due-diligence standard should apply to all brokers.
In agreement, the Final Regs reserve on the applicability of the broker reporting rules to non-U.S. brokers (whether money transmitter businesses or not) and CFC digital asset brokers. Future regulations applicable to such types of brokers are expected to be finalized in sufficient time for the United States to begin exchanges of information in compliance with the CARF with appropriate partner jurisdictions in 2028 (with respect to transactions effected in the 2027 calendar year; 89 FR 56517).
Thus, the Final Regs explicitly provide that only a U.S. digital asset broker (as defined) is potentially subject to sales reporting obligations thereunder (Reg. §1.6045 1(a)(1)). Rules related to non-U.S. digital asset brokers and CFC digital asset brokers are reserved under the Final Regs (Reg. §1.6045-1(g)(4)(i)(A)(2)).
Carve-out for non-custodial industry participants and digital asset middlemen
The Final Regs provide that the definition of a broker is further limited to only conventional brokers and certain other industry participants that take custody of a customer’s assets (89 FR 56493).
The treatment of certain industry participants as having potential sales reporting obligations under the Proposed Regs when they were not brokers (within the pre-existing definition of the term for information reporting purposes) was a bit convoluted. It was achieved under the Proposed Regs via new rules regarding digital asset middlemen (under Reg. §1.6045-1(a)(21)) and the definition of a “facilitative service” under Reg. §1.6045-1(a)(21)(iii). Under the Final Regs, a custodial digital asset middleman is treated as “effecting sales,” which results in broker status (Reg. §§1.6045-1(a)(10)(i)(D) and (a)(1)). The Final Regs also provide that the definition of a digital asset constituting a covered security is limited to assets held by a broker providing custodial services (see below).
As noted in the preamble to the Final Regs, Section 80603(a) of the Infrastructure Act clarified the definition of a broker “to include any person who, for consideration, is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person” (89 FR 56492). The definitions of a digital asset middleman and a related “facilitative service” in the Proposed Regs (and as structurally retained, although partially reserved, in the Final Regs) were and are intended to address this clarification (id).
Notably, the potential inclusion of such non-custodial industry participants as brokers with information reporting obligations for sales of digital assets under the Proposed Regs was subject to substantial criticism in the comments received.
The Final Regs continue to treat industry participants in certain cases as brokers subject to broker information reporting obligations with respect to sales of digital assets; however, in general non-custodial industry participants are not treated as brokers because, as noted under the Final Regs, additional consideration of related issues remains necessary (89 FR 56492). Nevertheless, the preamble to the Final Regs indicated that rules for custodial brokers should not be delayed while the IRS resolves issues related to non-custodial industry participants (id). This explains why the Final Regs reserve on treating such participants as subject to sales reporting obligations thereunder (under Reg. §§1.6045-1(a)(21)(ii) and (iii)(A)), even though the preamble to the Final Regs indicates that the IRS intends to “expeditiously issue separate final regulations describing information reporting rules for non-custodial industry participants” (89 FR 56492).
The exclusion of non-custodial industry participants under the Final Regs means that both De-Fi arrangements of various kinds and unhosted digital wallet access providers are not intended to be subject to sales reporting obligations under the Final Regs (89 FR 56491). It also means that persons that solely provide “validation services without providing other functions or services, or persons that are solely engaged in the business of selling certain hardware, or licensing certain software, for which the sole function is to permit persons to control private keys …, are not digital asset brokers” under the Final Regs (89 FR 56492). Two examples in the Final Regs are intended to make it clear that such persons are not brokers under the Final Regs (even though the IRS continues to consider additional guidance relating to non-custodial industry participants; 89 FR 56492).
The Final Regs include a definition of both a “digital asset middleman” and a “facilitative service,” imposing a sales reporting obligation on certain custodial industry participants under the Final Regs (89 FR 56492-93). Additionally, there is a clear inclusion of providers of digital asset kiosks under the broker reporting rules (89 FR at 56493). Real estate reporting persons must also generally report with respect to digital asset transactions related to real estate sales under a knowledge standard (89 FR at 56493 and 97).
PDAPs required sales reporting and de minimis exceptions from reporting
A PDAP is defined as “a person who in the ordinary course of a trade or business stands ready to effect sales of digital assets … by regularly facilitating payments from one party to a second party by receiving digital assets from the first party and paying those digital assets, cash, or different digital assets to the second party” (Reg. §1.6045-1(a)(22)). Thus, an intermediary that facilitates the exchange of digital assets by a customer for payment to a third party, such as a merchant, is a PDAP. Because digital assets are exchanged by the transferor in these transactions, the PDAP can be considered to be effecting sales of such digital assets and these transactions can be reportable by the PDAP under the broker reporting rules (Reg. §1.6045-1(a)(9)(ii)(D)).
The inclusion of PDAPs as brokers under the Proposed Regs was subject to criticism (see, e.g., preamble discussion, 89 FR 56493-96). Several changes were made in the Final Regs in response. However, the Final Regs still require PDAP reporting of customer transactions as broker reportable sales under certain circumstances (id).
The Final Regs (as indicated in the preamble) are clear that, at least for now, a PDAP must take custody of a digital asset in order for there to be a reporting obligation under the Final Regs (89 FR at 56495). This requirement is incorporated in the definition of a PDAP under Reg. §1.6045-1(a)(22) as well as via corresponding aspects of the definition of a sale under Reg. §1.6045-1(a)(9)(ii)(D). This means that not every payment processor is a PDAP under the Final Regs, with the associated broker reporting obligations.
In addition, the Final Regs narrowed the applicability of these rules by only applying them if the PDAP can already “obtain customer identification information from the buyer in order to comply with AML [(anti-money laundering)] obligations” (89 FR 56494). Reg. §1.60451(a)(2)(ii) accomplishes this by narrowly defining a customer in connection with PDAP-related transactions to only those customers for which the PDAP has “an agreement or other arrangement” permitting the PDAP to verify the customer’s identity for AML purposes, including pursuant to general terms and conditions related to customer onboarding.
The Final Regs also include several important de minimis rules that can eliminate PDAP reporting in certain cases. First, there is a $600 annual de minimis exception from broker sales reporting (based on aggregate sales effected on behalf of a particular customer) under Reg. §1.60451(d)(2)(i)(C). Second, there is a $10,000 annual de minimis broker sales reporting exception (based on aggregate transactions of a single customer) related to sales of qualifying stablecoins (as defined) (Reg. §§1.6045-1(b)(10)(i)(B) and (b)(2)(i)(C)). Third, there is also a $600 annual de minimis broker sales reporting exception (based on aggregate transactions of a single customer) related to sales of specified NFTs (Reg. §§1.6045-1(b)(10)(iii)(B) and (b)(2)(i)(C)). All three of these de minimis reporting exceptions are potentially available with respect to PDAP sales. Finally, as further described below, backup withholding for PDAP-related sales of digital assets will not be required until further guidance is issued (Notice 2024-56, Sec. 3.05).
Real estate reporting persons
The obligation to report digital asset components of reportable real estate sales by including it in the definition of a sale has been retained in the Final Regs (Reg. §1.6045-1(a)(9)(ii)(B)).
However, the definition of a related facilitative service (relevant in connection with a digital asset middleman determination) has been narrowed under the Final Regs to require that the real estate reporting person must have actual knowledge (or ordinarily would know) “that digital assets were used by the real estate buyer to make payment to the real estate seller” (Reg. §1.6045-1(a)(21)(iii)(B)(2)). The rule further provides that a real estate reporting person is considered to have actual knowledge “if the terms of the real estate contract provide for payment using digital assets” (id).
Note that the reporting of digital assets under these new rules in connection with reportable real estate sales is delayed until 2026 (Reg. §1.6045-1(q)). In addition, backup withholding will not be required until further guidance is issued (Notice 2024-56, Sec. 3.04).
Digital assets as a covered security
Generally
Cost basis reporting only applies to “covered securities,” a subset of “specified securities.” Although the definition of digital assets set forth in the Final Regs is broad, the definition of digital assets constituting covered securities is narrow.
Reg. §1.6045-1(a)(14)(v) provides that any digital asset as defined in Reg. §1.6045-1(a)(19) is a specified security. Reg. §1.6045-1(a)(15)(i)(J) defines a covered digital asset as a digital asset that constitutes a specified security that is “acquired in a customer’s account by a broker providing custodial services for such specified security on or after January 1, 2026, in exchange for cash, stored-value cards, different digital assets, or [certain specified] … property or services…”
Note that under the Final Regs, only digital assets (and related options and forwards) acquired on or after January 1, 2026, fall within the definition of covered digital assets (Reg. §§1.6045-1(a)(15)(i)(H), (J), and (K)). The Proposed Regs would have included such assets as covered securities if they were acquired on or after January 1, 2023 (Proposed Reg. §§1.6045-1(a)(15)(i)(H), (J), and (K)). The inclusion of assets acquired before the release of the Proposed Regs may have proven problematic to implement, as it would have required brokers to both track the basis and provide related reporting for previously acquired assets.
Reg. §1.6045-1(a)(15)(ii) defines the term “acquired in an account” for purposes of the covered securities rules. This rule slightly broadens the definition to also mean “acquired by another broker and delivered to the customer’s broker or custodian” as well as including the granting of an option and entering into a related forward contract or short sale.
Digital assets received in forks and airdrops
It should be noted that digital assets received in forks and airdrops would not likely constitute covered digital assets held within an account (unless they are somehow also received “in exchange for cash, stored-value cards, different digital assets, or [certain specified] … property or services …”). However, they would likely constitute noncovered securities and, as digital assets, would generally be subject to broker sales reporting. Moreover, the rules discussed above regarding the determinations of proceeds and basis for taxpayers selling digital assets would apply in connection with any reportable sales of such digital assets.
Other types of assets related to digital assets that constitute covered securities
In addition to digital assets themselves, the Final Regs treat certain forward contracts on digital assets as covered securities (Reg. §1.6045-1(a)(15)(i)(K)). The Final Regs also treat certain options on digital assets (with digital assets as an underlying property) as covered securities (Reg. §1.6045-1(a)(15)(i)(H)). In all cases, such forward contracts and options must be granted, entered into, or acquired on or after January 1, 2026 (Reg. §1.60451(a)(15)(i)(H) and (K)).
Hosting
The Final Regs do not require that the broker itself host the wallet in order for a digital asset to be considered a covered security. Note that under the definition of a digital asset constituting a covered security in Reg. §1.60451(a)(15)(i)(J), it is required that the broker provide custodial services. However, the preamble clarifies that the broker can do this indirectly via agents that perform all or some of the hosted wallet services (89 FR 56498).
Exemptions from reporting for sales to other brokers—multi-broker reporting
Reg. §1.6045-1(c)(3)(i) provides a broker exemption from reporting for sales made to various exempt recipients. Reg. §1.6045-1(c)(3)(iii) provides another exemption that can be available when multiple brokers are involved in the same sale of a customer’s securities. This provision is generally intended to eliminate duplicative reporting of the same sales transactions by more than one broker. If applicable, the multi-broker rule requires that “only the broker responsible for paying the holder redeemed or retired, or crediting the gross proceeds on the sale to that holder’s account, is required to report the sale” (id).
The pre-existing exemptions were considered inadequate for digital asset brokers because there were concerns that a digital asset broker would not clearly qualify for one of the listed exemptions (89 FR 56497). In response to these concerns, the Final Regs added U.S. digital asset brokers to the list of exempt recipients but require that such a recipient provides the paying broker with a certificate (on a properly completed backup withholding exemption certificate that would include the broker’s Taxpayer Identification Number (“TIN”) and signed under penalties of perjury) that the customer is a U.S. digital asset broker other than a registered investment advisor as specified therein (Reg. §§1.6045-1(c)(3)(i)(B)(12) and (C)(3)).The Final Regs also modified the multi-broker rule through the addition of Reg. §1.6045-1(c)(3)(iii)(B). Under this special rule related to sales of digital assets, only the broker that first credited the gross proceeds on the sale on the customer’s wallet or account is required to report the sale, and any other broker that would otherwise be required to report the sale under the Final Regs is exempted from reporting such sale, subject to the same certification requirements as above (id).
Broker sales and cost basis reporting for digital assets
General reporting rules
In general, the sales reporting rules for digital assets set forth in the Final Regs can be summarized as follows: (1) identify information reportable on a sale; (2) determine which lot was sold; (3) apply all mandatory basis adjustments to covered securities from transfer statements and issuer statements, if any (but see below); (4) determine the reportable sale date (timing) and the amount of gross proceeds from the sale; (5) determine the basis adjustments (and related holding period adjustments) that must be made (and cannot be made) to covered securities (if applicable); (6) determine if any special rules related to broker reporting for fixed investment trusts holding digital assets apply; (7) determine whether alternative reporting methods and de minimis reporting rules are available for stablecoins and NFTs; and (8) determine the additional information for sales that must be retained but not reported.
Required reported information
As noted above, sales of digital assets will be reported on the new Form 1099-DA (which, although updated on September 9, 2024, has not yet been finalized as of the drafting of this article). Form 1099-DA is different from existing Form 1099-B that is used to report required sales of other types of assets by brokers, and it is recommended that readers compare one form against the other.
The Final Regs impose specific reporting requirements. Reg. §1.6045-1(d)(2)(i)(B) provides that except for qualifying stablecoin, specified NFT, and PDAP sales for which applicable de minimis exceptions are available, a broker must generally report the following new information on Form 1099-DA (in addition to the information which was previously required on Form 1099-B): (1) whether the sale was for cash, stored-value cards, or in exchange for services or other property; (2) for sales of transferred in digital assets, the date of the transfer in and the number of units transferred into the wallet or account by the customer; (3) whether the broker took into account customer-provided acquisition information from the customer or the customer’s agent when determining the identification of the units sold; and (4) any other information required by the form or instructions.
Additionally, for any sale of a covered digital asset, or related covered option or forward contract, a broker must also report the following information on sale: (1) the adjusted basis of the covered security sold calculated in accordance with the regulation; (2) the date such covered security was purchased, and whether any gain or loss with respect to the covered security sold is long-term or short term as determined in accordance with the regulation; (3) for purpose of determining basis, the asset’s purchase date and whether any gain or loss with respect to the sale is long-term or short-term (in the case of an option and any asset delivered in settlement of an option, the broker must apply any applicable rules set forth in the regulations); and (4) in the case of a tokenized security, the broker must make appropriate basis and holding period adjustments by applying the wash sale rules as applicable, stock basis averaging rules as applicable, option and debt related basis adjustments as applicable and report any other information required by the form or instructions (Reg. §1.6045-1(d)(2)(i)(D)).
Determining which lot is sold
When a security is sold14 and a broker holds more units of the security than are sold, it must be determined which units were included in the sale and which units were not. Reg. §1.6045-1(d)(2)(ii)(A) sets forth general rules specifying that, except for stock for which stock averaging has been elected, the specific lots that are sold are based on the taxpayer’s adequate and timely identification of the security to be sold, which must be communicated to the broker. These rules apply to both covered and noncovered securities (id).
Reg. §1.6045-1(d)(2)(ii)(B) explicitly provides that in the case of sales of digital assets, the broker’s determination of which units are sold must be consistent with the taxpayer’s determination, provided the taxpayer provides adequate identification of the units to be sold.
Under Reg. §1.6045-1(d)(2)(ii)(C), if (1) the taxpayer does not provide the broker with adequate identification of units to be sold by the date and time of the event referenced, and (2) the broker does not have adequate transfer in information or acceptable taxpayer-provided acquisition information, then the broker must first report the sale of units not acquired by the broker for the taxpayer. Once such units are sold, the broker must then treat the remaining digital assets as sold in order of time from the earliest date on which units of such digital assets were acquired by the taxpayer (id). Moreover, if a broker does not receive broker-acceptable taxpayer-provided acquisition information with respect to digital assets transferred into the taxpayer’s account, the broker must treat those units as acquired as of the date and time of the transfer (id). Collectively, these rules set forth the Final Regs’ tiered FIFO method of lot relief.
In general, for broker reporting purposes (under rules similar to the rules discussed above that are applicable to a taxpayer under Reg. §1.1012-1(h)), a taxpayer must specify to the broker the units to be sold (no later than the time and date of the sale.) A taxpayer’s reference to particular units must be sufficiently specific (as determined by the broker) so that the broker can identify the units sold. Under the Final Regs, a standing order constitutes adequate identification (id). If a broker offers only one method of unit identification, such method is treated as a standing order or instruction.15
Moreover, a broker can, if it so chooses, generally rely on taxpayer-provided acquisition information for transferred units in connection with the making of adequate identification of units sold (id). Taxpayer-provided acquisition information means “reasonably reliable information, such as the date and time of acquisition of units of a digital asset, provided by a customer or the customer’s agent to the broker no later than the date and time of a sale …” and includes “purchase or trade confirmations at other brokers or immutable data on a public distributed ledger” (id). For information reporting penalties under Code Secs. 6721 and 6722, a broker is deemed to have relied on such information in good faith for purposes of identifying which units were sold if the broker neither knows nor has reason to know that the information is incorrect (id). The Final Regs also include a deemed identification rule for units of digital assets that are received and withheld for related payment of either backup withholding tax or transaction costs whereby the basis of such withheld units is deemed to be allocated to the sale of the withheld units (Reg. §1.6045-1(d)(2)(ii)(B)(3)).
Basis adjustments from transfer and issuer reporting
In general, Reg. §1.6045-1(d)(2)(iv)(A) requires that brokers must take into account all information provided on transfer and issuer statements as required to be provided under Code Secs. 6045A and 6045B (other than the classification of security) unless the statement is incomplete or the broker has actual knowledge that it is incorrect.
Transfer reporting does not generally apply to covered digital assets because part of the definition of a covered digital asset in Reg. §1.6045-1(a)(15)(J) requires that the digital asset must be acquired in the broker’s account. However, a broker may choose to provide transfer reporting in connection with the transfer of tokenized securities. Such discretionary transfer reporting may be desired for purposes of tracking positive basis adjustments related to any tokenized securities subject to the wash sale rules or basis adjustments applicable to securities such as debt instruments or certain options.
Issuer reporting may include applicable basis adjustments that apply to certain covered digital assets such as tokenized securities. However, Reg. §1.6045-1(d)(6)(i) explicitly provides that in the case of sales of digital assets, a broker is not required to make basis adjustments reported by issuers. Thus, unlike for other types of covered securities, basis adjustments to covered digital assets by brokers based on issuer reporting is permitted but not required. This language does not appear to require consistency in adjustment; given the potential implications, this may be an oversight.16
As discussed above, a broker is not permitted to adjust the basis of digital assets without penalty risk based on information from customers or third parties under Reg. §1.6045-1(d)(2)(iv)(B).
Determining the timing and amount of sales proceeds for sales of digital assets
General rule
Sales of digital assets are reported on the date recorded in the related distributed ledger or in the broker’s books and records (for off-chain transactions) (Reg. §1.60451(d)(4)(ii).
The reportable gross proceeds from the sale of a digital asset are generally defined under the Final Regs as “the sum of the total cash paid to the customer or credited to the customer’s account from the sale plus the fair market value of any property or services received (including services giving rise to digital asset transaction costs), reduced by the amount of [allocable] digital asset transaction costs” (Reg. §1.6045-1(d)(5)(ii)(A)).17
Fair market value is measured on the date and at the time the transaction is effected, and for valuation, a reasonable valuation method that looks to contemporaneous evidence of value must be used (Reg. §1.6045-1(d)(5)(ii)(A)(1)).18 If services give rise to digital asset transaction costs, the broker must look to the fair market value of the digital assets used to pay such costs (id). And, in determining the fair market value of a digital asset, a “broker may perform its own valuations or rely on valuations performed by a digital asset data aggregator as defined in [the regulations] …, provided such valuations apply a reasonable valuation method for digital assets as described in [the regulations]” (id). The Final Regs provide that “the value of what is received should ordinarily be identical to the value of the digital asset exchanged” (Reg. §1.6045-1(d)(5)(ii)(A)(2)). If there is a disparity between the value of the services or property received and the digital asset exchanged, the fair market value of property and services received controls. If the broker (or digital asset data aggregator) reasonably determines that the fair market value of the property or services received cannot be ascertained with reasonable accuracy, the fair market value of such property or services is generally determined by reference to the fair market value of the digital asset sold (id). If the broker (or digital asset data aggregator) reasonably determines that neither the fair market value of the asset sold or the property or services received can be ascertained with reasonable accuracy, the broker must report that the received property or services have an undeterminable value.Reg. §1.6045-1(d)(5)(ii)(A)(3) provides that a reasonable valuation method for valuing digital assets must consider and appropriately weigh the pricing, trading volumes, market capitalization, and other relevant factors in valuing such assets. Moreover, it cannot give “an underweight effect to exchange prices lying near the median price value, an overweight effect to digital asset trading platforms having low trading volume, or otherwise inappropriately weigh … factors associated with a price that would make that price an unreliable indicator of value” (id).19
Because tokenized securities are a type of digital asset under these rules, gross proceeds are determined as of the time of sale (Reg. §1.6045-1(d)(5)(ii)(A)(1)), and the averaging rule for computing the amount of sales proceeds for identical stock (Reg. §1.6045-1(d)(5)(i)) is unavailable. This could potentially result in differences in the amount of proceeds reported between sales of tokenized securities and direct sales of underlying securities.
Computing the reportable basis for sales of covered digital assets
Determining the cost basis of a covered digital asset that should be reported by a broker when it is sold is based on the interplay of several rules.
First, it must be determined which particular digital asset is being sold under Reg. §1.6045-1(d)(2)(ii). To the extent the taxpayer is selling less than all of a particular digital asset, it is necessary that the taxpayer either adequately identify and timely communicate to the broker the particular lot or unit of the digital asset being sold, or the broker must use the tiered FIFO method described above to determine the lot or unit sold.
Second, the initial basis of the digital asset being sold must be determined. In general, the initial basis of a digital asset acquired for cash is determined by reference to the amount of cash paid for the asset plus the costs of acquiring the asset (but only to the extent not taken into account in the computation of gross proceeds under the regulations). If acquired for property other than another digital asset (or certain debt instruments), its initial basis is equal to the fair market value of the digital asset received plus any allocable digital asset transaction costs (Reg. §1.6045-1(d)(6)(ii)(C)(1)). As noted above, if digital assets are acquired in exchange for other digital assets, the related transaction costs may not be allocable to the acquired digital asset because instead they are allocated to the disposed digital asset. The fair market value of the digital asset must be based on a reasonable valuation method as described above. If the broker or digital asset data aggregator reasonably determines that neither the value of the digital asset received nor the value of the property transferred can be determined with reasonable accuracy, the fair market value (and therefore initial basis) of the received digital asset must be treated as zero.20
There are generally no other basis adjustments required to be made for covered digital assets (except for the subset of digital assets that constitute tokenized securities as discussed below and possibly for any digital assets if issued by a regulated investment company or real estate investment trust pursuant to Reg. §1.6045-1(d)(6)(vi)).
Wash sales and other basis adjustments for tokenized securities
For tokenized securities, the Final Regs require the appli cation of the wash sale rule and other basis adjustments applicable to stock and debt instruments (Reg. §§1.6045 1(d)(2)(i)(D)(4), (d)(6)(iii)(A)(2), and (d)(7)(ii)(A)(2)). Consistent with the pre-existing rules for covered securities (Reg. §1.6045-1(d)(6)(iii)(A)(1)), the preamble to the Final Regs indicates that the wash sale rule is applied to both the tokenized security and the underlying security (89 FR 56488).
Issues with tokenized securities and corporate actions
The Final Regs provide that a broker is not required to adjust the basis of a covered digital asset for adjustments reported on issuer statements (Reg. §1.6045-1(d)(6)(i)). Because tokenized securities are a type of digital asset (though subject to special rules), this rule effectively means that broker basis adjustments provided by an issuer related to tokenized securities are generally optional (at the discretion of the broker). Moreover, brokers cannot make other adjustments to the basis of covered digital assets without the risk of tax reporting penalties due to the carve-out for digital assets from potential penalty relief under Reg. §1.6045-1(d)(2)(iv)(B). Such results for tokenized securities seem counterintuitive. It also places substantial reliance on the completeness of issuer reporting of organizational actions affecting the basis for tokenized securities under Code Sec. 6045B. Our experience has been that issuer reporting of such actions under U.S. tax law on Form 8937, particularly by issuers located outside of the United States, has proven to be less than complete.
Reporting the basis of noncovered digital assets sold
Unlike the restrictions and requirements applicable to the computation of basis for digital assets constituting covered securities as just described, there is penalty relief related to the computation of adjusted basis (and the determination of whether gain or loss is short term or long term) reported for noncovered securities (if identified as such when reported), including digital assets (Reg. §1.60451(d)(2)(iii)(A)).
Although there is penalty relief for brokers related to the reporting of the basis for identified noncovered securities, brokers may be challenged in consistently reporting the basis of noncovered digital assets between different customers because of potential differences in the reconciliation of each customer’s own calculations of basis with broker reported amounts for noncovered securities on Form 8949.
Exchange traded funds and fixed investment trusts holding digital assets
Reg. §1.6045-1(d)(9) provides rules relating to broker reporting when digital assets held by a fund structured as a grantor trust for federal income tax purposes are sold. These rules generally require broker sales reporting unless the information is also reported under the WHFIT reporting rules of Reg. §1.671-5. The rules further provide that “to the extent that this section requires additional information under Code Sec. 6045(g), those requirements are deemed to be met through compliance with the rules in Reg. §1.671-5.”
The preamble contemplates dual-level reporting of sales of digital assets held by such a WHFIT—first by the WHFIT and then by the customer’s broker (89 FR 56490). However, the WHFIT reporting rules of Reg. §1.671-5 include exceptions from sales reporting that might prevent a broker from knowing that a digital asset has been sold, which would necessarily prevent a broker from then reporting such a sale. WHFITs do not currently provide cost basis information in connection with excepted sales of their underlying assets (although there is a basis reporting obligation in Reg. §1.671 5(b)(2)(iv)(A)(3) for sales that are not excepted under the regulations).21
Alternative reporting and de minimis rules
There are two key alternative reporting methods and de minimis rules set forth in Reg. §1.6045-1(d)(10) that are generally available to brokers (as well as to sales by PDAPs as discussed above). One is for certain stablecoins and one is for certain NFTs. Stablecoins are often referred to and used as on and off ramps between fiat currencies and other types of digital assets. NFTs are unique digital assets that are most commonly used to digitally signify ownership of something. The alternative reporting methods and related de minimis rules included in the Final Regs are intended to substantially reduce broker sales reporting for digital assets (see, e.g., preamble discussion related to the potential burden of stablecoin reporting versus the benefit, 89 FR 56504-05).
Qualifying stablecoin sales
As mentioned above, stablecoins are sometimes used as a momentary bridge asset in order to exchange one digital asset for another. The disposition of stablecoins may lead to a gain or loss, but it would likely be small and, if exchanged for another digital asset, would ultimately be reflected when the received digital asset is eventually sold. Sales of a qualifying stablecoin in exchange for a different digital asset (that is not also a qualifying stablecoin) is called a non-designated sale and does not have to be reported at all (Reg. §1.6045-1(d)(10)(i)(A)). And, to the extent all other “designated” sales (as defined in Reg. §1.6045 1(d)(10)(i)(C)) of qualifying stablecoins (reduced by allo cable digital asset transaction costs) during the calendar year by a customer do not exceed $10,000, such designated sales are not reported pursuant to the de minimis rule for qualifying stablecoins (id).
In addition, if aggregate designated sales of qualifying stablecoins exceed the $10,000 de minimis threshold in a calendar year, an alternative reporting method is available and such designated sales can be reported on an aggregate basis (Reg. §1.6045-1(d)(10)(i)(A)). Under this method, sales reporting of each particular qualifying stablecoin is permitted on an aggregate basis (reported on a separate Form 1099-DA) provided all the following information is reported: (1) the name, address, and TIN of the customer; (2) the name of the qualifying stablecoin sold; (3) the aggregate gross proceeds for the year from designated sales of the qualifying stablecoin (after reduction for the allocable digital asset transaction costs); (4) the total number of units of the qualifying stablecoin sold in designated sales of the qualifying stablecoin; (5) the total number of designated sale transactions of the qualifying stablecoin; and (6) any other information required by the form or instructions (Reg. §1.6045-1(d)(10)(i)(B)). The cost basis of a sold qualifying stablecoin is not reported under the alternative reporting method.
Note that aggregate gross proceeds (as reduced by allocable digital asset transaction costs) for sales of qualifying stablecoins must be carefully tracked both because the aggregate total for all qualifying stablecoins sold during the year is needed for determining if the total amount sold for the year is de minimis and the aggregate amounts of each particular type of qualifying stablecoin sold may also be needed for reporting purposes under the alternative reporting rules if the de minimis rule is exceeded. The overall threshold is applied as a single threshold regardless of how many accounts or wallets a customer has with the broker (89 FR 56505).
In order for a stablecoin to constitute a qualifying stablecoin, it must satisfy three requirements: (1) it must be designed to track a single government or central bank convertible currency on a one-for-one basis; (2) it must have a stabilization mechanism of one of two types to demonstrate that it is stable; and (3) it must generally be accepted as payment by persons other than its issuer, including PDAPs (Reg. §1.6045-1(d)(10)(ii)). Allowed stabilization mechanisms include one “that causes the unit value of the digital asset not to fluctuate from the unit value of the convertible currency it was designed to track by more than 3% over any consecutive 10-day period, determined using Coordinated Universal Time (“UTC”), during the calendar year” and a mechanism whereby “[t]he issuer of the digital asset is required by regulation to redeem a unit of the digital asset at any time on a one-to-one basis for the same convertible currency that the digital asset was designed to track” (Reg. §1.60451(d)(10)(ii)(B)).
A stablecoin must satisfy these three conditions for the entire year in order to be a qualifying stablecoin (Reg. §1.6045-1(d)(10)(ii)). This means that a broker must be prepared to report sales of every stablecoin under the general rules of the Final Regs in case a particular stablecoin fails to satisfy any of the three requirements at any point during the calendar year.
As discussed below, there is a special backup withholding rule included in the Final Regs related to stablecoins that lose their qualifying status.
Specified NFT sales
There is also an alternative reporting method and de minimis reporting exemption for certain sales of “specified NFTs” (Reg. §1.6045-1(d)(10)(iii)(A)). A specified NFT must meet three requirements; it must be (1) indivisible (it cannot be divided into smaller units without losing its intrinsic value or function); (2) unique; and (3) cannot be an interest in a specified type of asset including a security, a commodity, a regulated futures contract, a forward contract or a digital asset that does not satisfy the first two tests specified (all as defined in Reg. §§1.6045-1(a)(3) and (5–7) and 1.6045-1(d)(10)(iv)).
NFTs that do not qualify as specified NFTs are ineligible for this alternative reporting method and the related de minimis reporting exemption (id). The de minimis reporting exemption for all specified NFT sales for the calendar year is just $600, substantially lower than the one available for qualifying stablecoins (id). Under the applicable reporting rules for sales in excess of the de minimis amount, separate reporting for each type of specified NFT is not required or contemplated. Instead, a single Form 1099-DA is required for reporting all such sales (in the manner specified by such form or instructions), and the following information must be reported for such sales: (1) the name, address, and TIN of the customer; (2) the aggregate gross proceeds for the year from all sales of specified NFTs (after reduction for allocable digital asset transaction costs); (3) the total number of specified NFT sales; (4) to the extent ordinarily known by the broker, the aggregate gross proceeds that is attributable to the first sale by a creator or minter of the specified NFT; and (5) any other information required by the form or instructions (Reg. §1.6045-1(d)(10)(iii)(B)). The cost basis of a sold specified NFT is not reported under the alternative reporting method.
As is the case with qualifying stablecoin sales, the aggregate gross proceeds (as reduced by allocable digital asset transaction costs) for sales of all specified NFTs during the year must be carefully tracked both because the aggregate total for all specified NFTs is needed for determining if the total amount sold for the year is de minimis and for reporting purposes under the alternative reporting method if the de minimis rule is exceeded.
As discussed below, sales of specified NFTs are not currently subject to backup withholding tax (Notice 2024-56, Sec. 3.03).
Reporting and threshold computations for joint accounts
The Final Regs clarify how aggregate gross proceeds are computed for both the alternative rules for qualifying stablecoins and specified NFTs (as well as the PDAP de minimis rule of Reg. §1.6045-1(d)(2)(i)(C)) when the information returns are for joint accounts (Reg. §1.60451(d)(10)(v)). For such purposes, the customer is the taxpayer whose TIN would be required to be shown on the return after the application of the backup withholding rules of Reg. §31.3406(h)-2(a) (id).
