Digital Asset Rules Show Interplay of Basis Tracking, Reporting

Treasury and IRS regulations governing digital assets, some of which become effective Jan. 1, represent a major milestone in the evolution of this new asset class.

The regulations, issued earlier this year, are remarkable in that they recognize digital assets’ growing use and impact. They also constitute a major step in an evolving regulatory process, and they consider taxpayers who self-custody their digital assets—a major point of ownership for many digital asset holders.

Sections 1012 and 6045 of the tax code, which govern basis of property costs and rules for brokers, are the regulations’ two core pillars. Considering the interplay of these two pillars with the respective responsibilities of taxpayers and brokers is integral.

Individual Taxpayers

Whether individual taxpayers are self-custodying or rely on a broker, the new rules become effective on Jan. 1. Taxpayers should be ready to comply with the regulations. To gain the most strategic options for transacting in digital assets while potentially reducing tax burdens, taxpayers must be ready to track and manage the basis for their digital asset transactions and document their methodologies.

This means there needs to be a strict tracking of basis, or purchase prices, by asset within specific wallets and addresses. If the taxpayer can’t track and identify assets prior to use or disposal, then they must rely on first in first out—in which the earliest acquired cryptocurrencies are sold first—within each wallet.

Conversely, if they have tracked and identified their assets systematically, they have several other options to determine their lot relief methodology, which determines how assets are liquidated in a sale. These include specific identification, last in first out (selling the last digital asset you purchased first), and highest in first out (using the highest-valued asset to determine a tax obligation).

Taxpayers must be able to demonstrate the intended tax basis methodology before a transaction is settled. If dealing with a broker for custody, under Section 1012, the burden of basis tracking and identification instructions falls clearly on the taxpayer. That’s because some brokers haven’t yet implemented the systems to accept specific instructions from their customers.

Brokers

Beginning Jan. 1, 2025, brokers will be required to report gross proceeds from the sales of digital assets. The basis reporting for covered securities (securities purchased on the broker platform) will start to phase in on Jan. 1, 2026. Although the reporting dates are unchanged from the proposed rules, the date on which a digital asset is considered a covered security shifted from Jan. 1, 2023, to Jan. 1, 2026.

If the customer is dealing with a broker who provides wallets, the customer must provide trustworthy information and documentation so the broker can undertake the appropriate lot selection at the time of the sale.

In selecting a broker who will also custody one’s digital assets, the taxpayer is confirming that the broker will rely on the information and documentation provided to make the lot selection, or specific quantity of cryptocurrency units, for sales. In doing so, the taxpayer is also acknowledging that they are maintaining appropriate cost basis information and are readying themselves for 2026. That’s when the broker will presumably have systems in place to begin reporting the date of acquisition and basis of acquired digital assets.

From the broker’s perspective, several matters require attention beyond reporting the gross proceeds of digital asset transactions beginning Jan. 1, 2025. They will need to focus on implementing a transaction tracking system to capture cost basis to be ready for 2026.

Brokers also will need to work on taxpayer expectations for reporting. That means the broker, in issuing the new Form 1099-DA, will presumably do so in a centralized fashion—by providing an aggregated record of the digital transactions instead of a 1099 for each transaction. That is very different from conventional securities, which require a separate reporting form for each transaction.

While brokers will be assuming new burdens and responsibilities by 2026, there are three additional points to bear in mind. First, during phase-in, Notice 2024-56 provides brokers with relief from penalties for sales executed in 2025 if the broker made a good faith effort to comply with reporting requirements.

Second, relief is also granted for backup withholding under Notice 2024-56. Backup withholding isn’t required on digital asset sales occurring in 2025. This delay enables brokers to collect individual taxpayer identification numbers and to prepare to comply with the backup withholding/deposit requirements.

Finally, for sales prior to 2027, no backup withholding penalty will be assessed if a broker withheld 24% of a customer’s proceeds in digital assets. But the value of the withheld digital assets decreased between withholding and liquidation to pay the IRS (assuming the liquidation occurred almost immediately after receiving the sales proceeds).

If brokers missed reporting requirements but performed the 24% backup withholding, they should still fare reasonably well. But if they missed the backup withholding, the situation could be more dire. The penalties for non-reporting are capped, but those for failure to withhold remain uncapped.

While the new rules on basis tracking and reporting provide for much-needed clarity on these transaction types, they may impose a change in the way some taxpayers execute and record crypto-based transactions.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rob Massey is partner at Deloitte Tax and tax leader of the firm’s blockchain and digital assets practice.

Conor O’Brien is a senior manager at Deloitte Tax focusing on blockchain and digital assets.

Jonathan Cutler is a senior manager at Deloitte Tax in the Washington national tax practice.

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