Understanding IRS Final Regulations on Digital Assets: What You Need to Know

Did You Know Your Crypto Transactions Will Be Under Closer Scrutiny Starting in 2025? Here’s What You Need to Know to Stay Compliant.

Introduction

Starting in 2025, the Internal Revenue Service (IRS) will be keeping a much closer eye on your crypto transactions. The U.S. Department of the Treasury and the IRS have now issued final regulations requiring custodial brokers (platforms you use to trade crypto, like Coinbase or Binance) to report sales and exchanges of digital assets. This means more accurate tax filings and fewer chances for tax evasion. Let’s break down what this means for you, and what you need to do to stay compliant.

Background

These new rules come from changes to the Internal Revenue Code by the Infrastructure Investment and Jobs Act (IIJA), which was enacted in 2021. The goal is to close the tax gap by making sure that income from digital asset sales and exchanges is accurately reported. The IRS considered over 44,000 public comments before finalizing these regulations to balance industry implementation challenges and the need to prevent tax evasion. It’s important to note that these regulations do not introduce new taxes on digital assets but rather create reporting requirements to help taxpayers file accurate returns and pay taxes already owed under current law.

Who Needs to Pay Attention?

The rules impact a broad array of stakeholders, including:

• Individual Investors: Those trading cryptocurrencies or holding digital assets.
• Exchanges and Brokers: Platforms facilitating digital asset transactions.
• Businesses: Entities accepting cryptocurrencies as payment or holding them on their balance sheets.

Key Changes in the Regulations

1. Clear Definition of Digital Assets

Before these regulations, there was a lot of confusion about what counted as a digital asset. Now, the IRS has defined a digital asset as a digital representation of value recorded on a cryptographically secured distributed ledger, like blockchain technology. This includes cryptocurrencies, stablecoins, and NFTs (non-fungible tokens).

Example: Bitcoin, Ethereum, and NFTs like CryptoPunks are all considered digital assets under the new definition.

2. Reporting Requirements for Crypto Platforms

Starting in 2025, the platforms you use to trade crypto must report the gross proceeds from the sale of digital assets. This means they will file information returns and provide you with statements for your tax filings, similar to how stock transactions are reported. This is part of the IRS’s effort to ensure that all income from digital asset transactions is accurately reported and taxed.

Starting in 2026, the reporting requirements will expand to include the cost basis of digital assets. This additional information is crucial for accurately calculating gains or losses from crypto transactions.

3. Backup Withholding Rules

The new regulations also introduce backup withholding rules to ensure taxes are withheld on certain transactions, reducing the likelihood of underreporting.

Example: If a taxpayer fails to provide a correct Taxpayer Identification Number (TIN) to the platform, the platform must withhold a percentage of the transaction proceeds as backup withholding.

4. Transitional and Penalty Relief

The IRS understands that these new rules are a big change and has provided some transitional and penalty relief to help everyone adjust.

Transitional Relief: Brokers and taxpayers will have a grace period to adjust to the new reporting requirements. During this period, the IRS will provide guidance and support.

Penalty Relief: During the transitional period, the IRS will waive penalties for certain reporting errors and omissions, provided that brokers and taxpayers make a good faith effort to comply with the new regulations.

Example: If a platform reports incorrect information and doesn’t correct it, they might face penalties. However, the IRS will provide some relief if the platform shows it tried to comply.

Additional Guidance and Transitional Relief

Notice 2024-56: General Transitional Relief

Notice 2024-56 provides general transitional relief from reporting penalties and backup withholding for brokers who do not timely and accurately file information returns and furnish payee statements for sales and exchanges of digital assets during calendar year 2025, provided they make a good faith effort to comply with the reporting obligations. Additionally, it provides limited relief from backup withholding for certain sales of digital assets during 2026 for brokers using the IRS’s TIN-matching system.

Notice 2024-57: Delay on Information Reporting for Certain Transactions

Notice 2024-57 informs brokers that until further guidance is issued, they will not have to file information returns or furnish payee statements on digital asset sales and exchanges for six types of transactions:

• Wrapping and unwrapping transactions
• Liquidity provider transactions
• Staking transactions
• Transactions described by digital asset market participants as lending of digital assets
• Transactions described by digital asset market participants as short sales of digital assets
• Notional principal contract transactions

5. Special Rules for Real Estate Transactions

Starting January 1, 2026, real estate professionals must report the fair market value of digital assets paid by buyers and received by sellers in these transactions.

Example: If a buyer pays for a property with Bitcoin valued at $500,000, the real estate broker must report this amount to the IRS.

6. Optional Aggregate Reporting for Stablecoins and NFTs

The regulations provide an optional, aggregate reporting method for certain sales of stablecoins and NFTs, applicable only after sales exceed de minimis thresholds.

Example: If Mike trades stablecoins frequently, instead of reporting each transaction individually, his platform can report the aggregate totals for the year, provided the trades fall below a specified threshold.

7. Transition from Universal or Multi-Wallet Approach

Old System: Taxpayers could allocate the basis of their digital assets across multiple wallets or accounts and use different cost flow assumption methods such as FIFO, LIFO, or HIFO to calculate gains, often choosing the most tax-efficient.

New System: Under the new rules, the specific identification or FIFO method and by-account basis tracking are mandatory. This means that the cost basis associated with a digital asset must remain tied to the specific account where it was initially recorded unless it is explicitly transferred to another account.

Example: Previously, if Alice had Bitcoin in multiple wallets, she might have allocated her basis across all her wallets. Now, she must allocate the basis for the Bitcoin in each wallet separately, based on the transactions in that specific wallet.

8. Basis Allocation for Digital Assets Starting January 1, 2025

Purpose:

Revenue Procedure 2024-28 provides a safe harbor under § 1012(c)(1) for taxpayers to allocate the unused basis of digital assets held in their wallets or accounts as of January 1, 2025.

Key Takeaways for Taxpayers

1. Inventory and Basis Allocation:
   • Inventory of Assets: On January 1, 2025, taxpayers must take a snapshot of their digital assets held in each wallet or account.
   • Identify Basis: Allocate the unused basis of these assets as of December 31, 2024, across the assets held in each wallet or account.
2. Record-Keeping Requirements:
   • Detailed Records: Maintain records of acquisition dates, purchase prices, and transaction details for all digital assets.
   • Specific Unit Allocation: If possible, allocate basis to specific units within each wallet or account based on identifiable characteristics such as purchase date or price.
3. Allocation Methods:
   • Specific Unit Allocation: Allocate basis to specific digital asset units within a wallet or account by referencing unique identifiers.
   • Global Allocation: Alternatively, use a global allocation method by ordering units of unused basis and allocating them to pools of remaining digital asset units across all wallets or accounts. This allocation must be non-discretionary and based on pre-determined rules such as the earliest acquisition date or highest basis.

9. How to Implement Basis Allocation

Step-by-Step Guide:

1. Snapshot of Digital Assets:
   • On January 1, 2025, document the digital assets held in each of your wallets or accounts. Include details such as the number of units, acquisition dates, and purchase prices.
2. Allocate Unused Basis:
   • Distribute the unused basis of digital assets across the units held in each account.
   • This can be done by specific identification (if records are sufficient) or by using a global allocation rule.

3. Example Scenario:

Let’s consider a taxpayer, John, who holds the following digital assets:

Coinbase Account: 1 BTC bought on January 1, 2023, for $20,000.

Binance Account: 2 BTC bought on June 1, 2023, for $10,000 each.

Before the new regulation: John could choose which BTC to sell for tax optimization. For example, he might select the BTC with the highest basis to minimize taxable gains.

Under the new regulation: John must use the FIFO method within each account. If he sells 1 BTC on Binance in 2025, he must use the basis of the BTC purchased on June 1, 2023, for $10,000, not the BTC purchased on Coinbase for $20,000.

Detailed Allocation:

Specific Unit Allocation: If John can specifically identify the units sold, he records the basis and acquisition date for each unit.

Global Allocation: If specific identification isn’t feasible, John uses a global allocation method, ordering the units by acquisition date or basis amount, and allocating them accordingly.

4. Practical Tips

• Maintain Comprehensive Records: Ensure that detailed transaction records are kept for all digital asset activities, including dates, amounts, and specific wallet or account information.
• Use Crypto Tax Software: To simplify tracking and reporting, utilize software that supports the new FIFO and by-account basis rules. I highly recommend Cointracking as one of the best crypto tax calculator tools.
• Consult a Tax Professional: Seek advice from professionals specializing in digital assets to ensure compliance and optimize your tax strategy. It’s crucial to have an accurate closing position of your crypto assets for 2024. This means making sure everything is accounted for and reconciled up to December 31, 2024. Your proceeds will be reported, so ensure you have the appropriate cost basis. If you haven’t already done so, start your crypto tax reconciliation now. Don’t wait until 2025—get everything in order to avoid any issues with your tax reporting.

Conclusion

Starting January 1, 2025, the IRS will scrutinize your crypto transactions more closely than ever before. The new reporting requirements for brokers and the mandatory FIFO and by-account basis rules highlight the importance of accurate crypto reporting. By following the practical tips outlined above, you can stay compliant and avoid potential penalties.

Remember, the key to staying ahead is preparation. Take an inventory of your digital assets, allocate your basis accurately, and ensure everything is reconciled by the end of 2024. Utilize tools like Cointracking to simplify your tracking and reporting process, and consult with a crypto tax accountant to ensure you’re on the right path. Don’t let the new regulations catch you off guard. 

Ready to take the stress out of your crypto taxes? Get in touch today.