The Internal Revenue Service (“IRS”) recently finalized Treasury Regulations (the “Final Regulations”) and published two notices and a Revenue Procedure (the “Transitional Guidance”) for broker reporting of certain cryptocurrency transactions.  A prior SKrypto Blog post describes the proposed regulations and the draft Form 1099-DA. The IRS considered over 44,000 comments and made several responsive changes to the proposed regulations, which are now contained in more than 400 pages of Final Regulations and Transitional Guidance. This Memorandum discusses the Final Regulations and the Transitional Guidance.

The Final Regulations take effect on September 9, 2024, but largely apply to transactions occurring on or after January 1, 2025. Form 1099-DA reporting will first occur in early 2026. A new draft of From 1099-DA was released on August 8, 2024, which is just over a month after the publication of the Final Regulations and Transitional Guidance.  For the first year of reporting (i.e., in respect of trading activity in 2025), the Transitional Guidance specifies that no penalties will be imposed if brokers make a good faith effort to comply with information reporting requirements.

Digital Assets Defined

The Final Regulations maintain the initial definition of “digital asset(s)”: a digital representation of value that is recorded on a cryptographically secured distributed ledger (or any similar technology), regardless of whether each individual transaction involving that digital asset is actually recorded on the cryptographically secured distributed ledger.

Taxpayer guidance is provided on so-called “dual classification assets,” which are tokenized assets that could be considered both a digital asset and a security, commodity or other financial instrument. Dual classification assets are reported on Form 1099-DA and not on Form 1099-B (where transactions of non-tokenized securities, commodities and other financial instruments are reported).

Broker Defined

The Final Regulations offer a narrower definition of the term “broker” for U.S. federal income tax information reporting purposes than the definition used more broadly in the tax code. Elsewhere, a broker subject to information reporting rules include “any person who, for consideration, is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”

The Final Regulations limit “brokers” to digital asset industry participants that take possession of digital assets being sold by their customers, such as operators of custodial digital asset trading platforms, certain digital asset hosted wallet providers, certain processors of digital asset payments (“PDAPs”), digital asset kiosks and certain real estate transactions where the buyer pays in digital assets.

Notably, non-custodial digital asset trading platforms (i.e., decentralized exchanges) and unhosted digital asset wallet providers are not included in the current definition and the IRS is expected to continue evaluating whether to treat these participants as brokers for information reporting purposes.

A PDAP facilitates payments between parties by receiving digital assets from one party and paying those assets to a second party or converting those assets into cash or a different currency and paying those assets to a second party. A PDAP may be an intermediary between a merchant of goods or services and an end user. Thus, a PDAP will have Form 1099-DA reporting obligations if it knows or ordinarily would know the nature of the transaction (to determine if it is a reportable transaction) and the gross proceeds from the transaction. The Final Regulations limit this obligation to PDAPs with rights to obtain customer identification information from a particular buyer to comply with AML obligations.

The Final Regulations also provide a limited rule for transactions involving multiple brokers with reporting obligations. Chronology matters in these cases; only the broker who is first responsible for crediting the gross proceeds on the sale to a customer’s wallet or account will report the sale on Form 1099-DA.

Reportable Sales

The Final Regulations clearly state that an exchange of one digital asset for another digital asset, differing materially in kind or in extent, as a taxable disposition. Generally, many transactions and trades of digital assets will be reportable on Form 1099-DA. Digital assets that are cleared or settled on certain cryptographically secured distributed ledger or network of interoperable distributed ledgers and futures contracts that are 1256 contracts for federal income tax purposes are reportable on Form 1099-B (which is the IRS form used for traditional financial instrument reporting.

Based on comments received, the IRS clarified in the Final Regulations that the following transactions are excepted from reporting on Form 1099-DA.

• Digital assets retained by the broker to pay the customer’s transaction costs.
• Digital assets sold by the broker to cover its backup withholding obligations, if the sale is “immediately after” the customer’s exchange of one digital asset for a different digital asset.
• Disposition of a digital asset representing loyalty program credits associated with a non-digital asset business, provided the digital asset is exchanged for goods or services (not other digital assets) and cannot be used outside the loyalty program’s own distributed ledger.
• Sales of digital assets used in “a video game or network of video games” that cannot be used outside of the game or network.
• Sales of digital assets offered by sellers of goods or services that can be redeemed for goods or services (other than cash, stored value cards or qualifying stablecoins) and cannot be used outside the seller’s distributed ledger.
• Settlement of a forward contract that references digital assets.

The Transitional Guidance also carves out the following transactions from reporting until the IRS issues further guidance: 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, and notional principal contract transactions.

The Final Regulations provide three limited carve outs from Form 1099-DA reporting obligations.   Brokers are not required to report (i) designated sales of qualifying stablecoins, if aggregate annual sales do not exceed $10,000, (ii) specific NFTs if the aggregate annual gross proceeds from sales of those NFTs do not exceed $600, and (iii) PDAP transactions if the aggregate PDAP sales do not exceed $600.  Brokers with customers that have designated sales of qualifying stablecoins in excess of $10,000 or specified NFT transactions in excess of $600, in each case on a per customer basis, may optionally report these transactions on an aggregate basis and no cost-basis reporting is required. PDAP transactions in excess of $600 must be reported on a transaction-by-transaction basis.  To fully explore these concepts, the below paragraphs describe the concepts of “designated sales,” “qualifying stablecoin” and “specified NFT”.

For these purposes, a designated sale is generally the transaction of a qualifying stablecoin for another qualifying stablecoin. Brokers are not required to report such sales of qualifying stablecoins that are non-designated sales of qualifying stablecoins under this optional method nor the mainstream reporting rules. For example, if a customer uses a qualifying stablecoin to buy another digital asset that is not a qualifying stablecoin, no information reporting is required under the optional reporting method for qualifying stablecoins. The IRS anticipates that by waiving reporting requirements for non-designated sales of qualifying stablecoins and providing a $10,000 annual allowance for designated sales of qualifying stablecoins, many customers of qualifying stablecoin transactions will enjoy lessened reporting requirements.

Qualifying stablecoin is defined as any digital asset that meets the following three conditions for the entire calendar year:

• the digital asset must be designed to track, on a one-to-one basis, a single convertible currency issued by a government or a central bank (including the U.S. dollar);
• the stablecoin must use one of two stabilization mechanisms:
  • a results-focused test, where a stabilization mechanism must cause 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 three percent over any consecutive 10-day period during the calendar year, or
  • a design-focused test, where the stabilization requirement is met if the digital asset issuer is subject to regulatory requirements requiring it to redeem the digital asset at any time on a one-to-one basis for the same convertible currency that the stablecoin was designed to track (this provides more certainty to brokers at the time of a transaction); and
• to be a qualifying stablecoin, the digital asset must generally be accepted as payment by persons other than the issuer.

To constitute a specified NFT, the digital asset must be indivisible (that is, the digital asset cannot be subdivided into smaller units without losing its intrinsic value or function) and must be unique (as determined by the inclusion of a unique digital identifier, other than a digital asset address, that distinguishes that digital asset from all other digital assets). Further, the digital asset must not provide its holder with an interest in certain excluded property, which includes assets previously subject to reporting under § 1.6045-1 of the pre-2024 regulations or any digital asset that does not satisfy either of the above two criteria.

Reportable Information

The Final Regulations generally favor taxpayers, providing ample time to implement the new reporting rules and lessening the burden of required information. Form 1099-DA requires reporting of the name of the digital asset sold, the gross proceeds from the sale (valued in U.S. dollars), and whether the consideration received in that sale was cash, different digital assets, other property or services. Reporting is captured on a per-transaction (as opposed to aggregate) basis.

The Final Regulations also favorably requirements to report the transaction time and for delay cost basis reporting. In addition to delaying cost basis reporting to sales occurring on and after January 1, 2026, the Final Regulations remove the obligation to report transaction IDs or hashes and digital asset address information. This information may be requested in the event of a tax audit but allows for less burdensome routine reporting processes. Brokers must still collect and retain records of such information for digital asset sales for seven years from the due date for the related information return filing.

Finally, the Transitional Guidance provides that taxpayers may use any reasonable method to allocate basis between units of digital assets. Revenue Procedure 2024-28 provides rules for allocating basis within a single wallet and between multiple wallets. This guidance will help taxpayers optimize their sales of digital assets for increased tax efficiency. This basis allocation information will also flow-through to the brokers for purposes of reporting sales on Form 1099-DA.

Gross Proceeds, Basis Reporting, Real Estate and Backup Withholding

The Final Regulations adopted proposals for purposes of determining gross proceeds. In the Final Regulations, fair market value should be measured as of the date and time the transaction was effected. Additionally, except in the case of services giving rise to digital asset transaction costs, to determine the fair market value of services or property (including different digital assets or real property) paid to the customer in exchange for digital assets, a broker must use a reasonable valuation method that looks to contemporaneous evidence of value of the services, stored-value cards, or other property.

The Final Regulations require brokers to report cost basis only with respect to digital assets acquired after cost-basis reporting goes into effect. Cost basis reporting is expected to take effect for sales occurring on or after January 1, 2026.  Cost-basis reporting will also be limited to sales of digital assets that were acquired, held until sale, and then sold by the customer within the same custodial broker. Therefore, there will be no cost basis reporting with respect to any digital assets that are transferred between brokers, and this is something trader will need to track on their own records.

Real estate transactions (that is, not trading real estate tokens, but actual buying and selling of the deeded hard asset) where the purchase contract provides for buyers to purchase real estate using digital assets are also subject to reporting. Generally, real estate transactions that go through brokers or agents are reported on Form 1099-S. The Final Regulations illustrate an example where a real estate acquisition using digital assets is reported both on Form 1099-S and Form 1099-DA. Real estate agents, brokers and title companies should be aware of these new requirements, as well as taxpayers exchanging real estate for crypto.

Finally, the Final Regulations and Transitional Guidance provide relief for the implementation of backup withholding with respect to reportable digital asset transactions. No backup withholding is required for sales occurring in 2025. Sales occurring in 2026 are subject to backup withholding, unless the account was opened prior to 2026 and the tax information provided by the accountholder matches IRS records. The Transitional Guidance also carves out the following from backup withholding: (1) a digital asset sale in return for an SNFT, (2) any digital asset for a real property sale effected by a real estate reporting person, and (3) any PDAP sale effected by a PDAP.

Final

The Final Regulations are expansive and may impact taxpayers, brokers and other participants in digital asset transactions differently. If you have questions about your position or engagement with digital assets, please contact a member of Seward & Kissel’s Blockchain and Cryptocurrency or Tax Groups.