On 28 June 2024, the US Treasury Department and the Internal Revenue Service (IRS) released final regulations addressing the calculation of gain or loss in digital asset transactions under sections 1001 and 1012 of the Internal Revenue Code. The final regulations will govern the determination of a taxpayer’s amount realized and adjusted basis in digital asset transactions and the allocation of digital asset transaction costs. These regulations accompanied final rules on digital asset broker reporting. The package of final regulations finalized proposed regulations published on 29 August 2023. In connection with the final regulations, the IRS released Revenue Procedure (Rev. Proc.) 2024-28, which provides transition guidance to assist certain taxpayers in applying the final regulations to digital assets acquired prior to 2025.
Background
In Notice 2014-21, the IRS stated that certain digital assets are treated as property for US federal tax purposes. Gain or loss from the sale or other disposition of property is defined in section 1001 as the difference between the taxpayer’s amount realized on the disposition and the taxpayer’s adjusted basis in the property. Section 1012 generally describes a taxpayer’s basis in property as the cost of the property, except as otherwise provided or adjusted.
Since 2019, the IRS has provided guidance on the calculation of gain or loss on digital assets held by taxpayers as capital assets through the FAQs on virtual currency transactions hosted on the IRS website. The FAQs provide for taxpayers to track the basis of individual units of digital assets and permit taxpayers to specifically identify which units of a digital asset are transferred in each sale or disposition. A taxpayer specifically identifies the units transferred to establish the adjusted basis to be applied in the calculation of gain or loss on the disposition as well as the holding period of the transferred property. If the specific units sold are not identified, a taxpayer is required to calculate gain or loss on the disposition (and determine the holding period of the transferred assets) by treating its earliest acquired units of the transferred digital asset as the units sold (a “first-in, first-out” or FIFO rule).
As a result of amendments to the Internal Revenue Code included in the Infrastructure Investment and Jobs Act (P.L. 117-58) enacted in 2021, section 1012 generally requires the conventions for the identification of the basis of digital assets sold or otherwise disposed of to be applied on an account-by-account basis after an applicable date (which will be 1 January 2025 under the final regulations).
Final regulations
Determination of amount realized
The amount realized from the sale or other disposition of a digital asset generally is the sum of the cash received and the fair market value of the property and services received in exchange, reduced by any digital asset transaction costs allocable to the disposition of the transferred digital asset. If the fair market value of the property and services received cannot be determined with reasonable accuracy, the fair market value of such property or services is considered to equal the fair market value of the digital asset disposed of at the time of the disposition.
Determination of basis
The basis of a digital asset is generally the cost of acquiring the asset, including any allocable transaction costs. If the digital asset is acquired through a purchase, the basis is the purchase price plus any allocable transaction costs. For digital assets acquired by an exchange of property, the basis is determined by reference to the amount realized of the property exchanged, which generally is the fair market value of the digital asset acquired at the time of the transaction.
Allocation of digital asset transaction costs
As described above, the final regulations require transaction costs allocable to the disposition of digital assets to reduce the amount realized on the disposition and transaction costs allocable to an acquisition of digital assets to increase cost basis. To determine whether costs are allocable to a disposition or an acquisition of digital assets, the final regulations provide that the full amount of transaction costs paid in connection with a sale or other disposition of digital assets is allocated to the disposition even in the case of an exchange of digital assets for other digital assets that differ materially in kind or extent.
In the case of digital assets acquired other than in an exchange of digital assets for digital assets, the digital asset transaction costs paid in connection with the acquisition of digital assets are allocable to the digital assets received.
Observations:
The proposed regulations had included rules splitting the digital asset transaction costs on an exchange of digital assets for digital assets between the basis of the acquired digital assets and the amount realized on the disposed of digital assets.
The final regulations remove the split digital asset transaction cost rule. The Treasury Department and the IRS acknowledged many comments raising several concerns with the split digital asset transaction cost rule and concluded that it would be overly burdensome for taxpayers and brokers to administer.
Cascading digital asset transaction costs
The final regulations also add special rules for allocating digital asset transaction costs on an exchange of digital assets in which units of the digital asset received are withheld to pay the transaction costs of the exchange. The final regulations provide that the total digital asset transaction costs paid by the taxpayer to effect both the original exchange and any disposition of the withheld digital assets are allocable exclusively to the disposition of digital assets in the original exchange.
Identification of digital assets sold, disposed of, or transferred
Digital assets not held in the custody of a broker
The final regulations provide that if a taxpayer sells, disposes of, or transfers less than all of the units of a digital asset that the taxpayer holds not in the custody of a broker, such as in an unhosted wallet, the basis and holding period of the units sold, disposed of, or transferred are determined by making a specific identification of the units in the wallet that are sold, disposed of, or transferred. A wallet is defined for this purpose as a means of storing, electronically or otherwise, a user’s private keys to digital assets held by or for the user. If a taxpayer does not specifically identify the units sold, disposed of, or transferred, the regulations determine the units disposed of to be the taxpayer’s earliest acquired units of that digital asset that are not held in the custody of a broker. For this purpose, the date any units were transferred into the taxpayer’s wallet is disregarded.
A specific identification is adequately made if, no later than the date and time of the disposition, the taxpayer identifies on its books and records the particular units to be sold, disposed of, or transferred by reference to any identifier, such as purchase date and time or the purchase price for the unit, that is sufficient to identify the units sold, disposed of, or transferred. A specific identification can be made only if adequate records are maintained for the unit of a specific digital asset to establish that a unit sold, disposed of, or transferred is removed from the wallet.
Observation: The Treasury Department and the IRS acknowledged comments criticizing the requirement that an adequate identification be made no later than the date and time of the transaction. One comment advised that the rule would provide less flexibility than currently allowed for making an adequate identification of which shares of stock a taxpayer sold and would pose a “trap for the unwary” for some taxpayers. The Treasury Department and the IRS responded that, in their view, the rules for specific identification of securities and digital assets are consistent in that both require a specific identification to be made before the relevant asset is delivered for settlement. Whereas the settlement period for securities is one or more days after a trade, the settlement period for digital assets is typically within minutes.
Digital assets held in the custody of a broker
For taxpayers that hold their digital assets in the custody of a broker, unless the taxpayer provides the broker with an adequate identification of the units sold, disposed of, or transferred, final regulations treat the units disposed of as the earliest acquired units of that digital asset held for the taxpayer in the custody of the broker. For this purpose, the earliest acquired units are determined by reference to the date the taxpayer acquired ownership of the units, and the date the units were transferred into the custody of the broker is disregarded.
An adequate identification is made if, no later than the date and time of the disposition, the taxpayer specifies to the broker the particular units of the digital asset to be sold, disposed of, or transferred by reference to any identifier, such as purchase date and time or purchase price, that the broker designates as sufficiently specific to identify the units disposed of. The taxpayer is responsible for maintaining records to substantiate the identification.
A standing order or instruction for the specific identification of digital assets is treated as an adequate identification made at the time of sale, disposition, or transfer. In addition, a taxpayer’s election to use average basis for a covered security for which average basis reporting is permitted and that is also a digital asset is also an adequate identification. In the case of a broker offering only one method of making a specific identification, such method is treated as a standing order or instruction.
Applicable date
The final regulations under sections 1001 and 1012 apply to all acquisitions and dispositions of digital assets on or after 1 January 2025.
Rev. Proc. 2024-28
Background
Rev. Proc. 2024-28 was issued contemporaneously with the final regulations to assist taxpayers in transitioning from prior practices of specifically identifying units or applying the FIFO rule based on a universal or multi-wallet approach to the rules in the final regulations, which apply the specific identification or FIFO rules to the units held within the single wallet or account from which the digital assets disposed of were transferred.
Overview
Rev. Proc. 2024-28 provides a safe harbor permitting taxpayers in certain circumstances to make reasonable allocations of units of cost basis among digital asset units held in multiple wallets or accounts prior to 1 January 2025.
Subject to certain requirements, the revenue procedure generally permits taxpayers to rely on any reasonable allocation of a number 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 and remaining units.
Scope of safe harbor
The safe harbor is available only to taxpayers who hold digital asset units that the taxpayer (i) acquires or receives in a transfer prior to 1 January 2025, and (ii) holds in the taxpayer’s wallet or account as of 1 January 2025 (“remaining digital asset units”). The safe harbor does not apply to any digital assets acquired by or transferred to the taxpayer on or after 1 January 2025.
The taxpayer may apply the safe harbor to one or more types of digital assets held by the taxpayer prior to 1 January 2025, separately with respect to each such type of digital asset. For example, Bitcoin is one type of digital asset, and Ether is another type of digital asset.
The safe harbor does not apply to any allocation of units of unused basis the amount or the availability of which is under consideration before any court of the US; before the IRS Independent Office of Appeals; or subject to an examination by the IRS, about which the IRS first contacts the taxpayer prior to 1 January 2025; unless, in each case, a final determination has been made with respect to the amount or the availability of such basis before the date the specific unit allocation or global allocation described below must be completed pursuant to the revenue procedure.
The safe harbor does not apply to the calculation of the amount of the taxpayer’s unused basis, which must be substantiated by the taxpayer.
The safe harbor is available only to a taxpayer who satisfies the eligibility requirements below. The failure to meet all the requirements with respect to one type of digital asset, however, does not affect the taxpayer’s ability to apply the safe harbor with respect to any other type of digital asset for which the taxpayer is able to satisfy the requirements.
Safe harbor eligibility requirements
Provided that the requirements of the revenue procedure are met, taxpayers are permitted to make reasonable allocations of units of cost basis among digital asset units held prior to 1 January 2025. Requirements include the following:
Each remaining digital asset unit must be a capital asset in the hands of the taxpayer.
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 section 1012.
Reasonable allocation
To make a reasonable allocation, the taxpayer must identify the remaining digital asset units and maintain records sufficient to show the units of unused basis by the applicable dates set forth below.
Any allocation of basis previously used in the calculation of gain or loss in a pre-2025 transaction to digital assets held by the taxpayer as of 1 January 2025 does not constitute a reasonable allocation.
The reasonableness of a taxpayer’s allocations to wallets or accounts is determined separately with respect to each type of digital asset held by the taxpayer prior to 1 January 2025.
A taxpayer may reasonably allocate units of basis to digital asset units on a specific unit basis or on a global basis.
Specific unit allocation
A specific unit allocation involves allocating specifically identified units of unused basis to either a pool of remaining digital asset units within each wallet or account or to the specific units of remaining digital assets within each wallet or account.
Example: Taxpayer holds four units of digital asset DE in Wallet A, which were acquired on 1 July 2019 for USD 1 per unit. Taxpayer also holds 20 units of DE in Wallet B, acquired on 1 September 2020 for USD 5 per unit. Taxpayer timely records in its books and records an allocation to the four units of DE held in Wallet A the following units of unused basis:
Two units of unused basis in the amount of USD 1 per unit with an acquisition date of 1 July 2019; and
Two units of unused basis in the amount of USD 5 per unit with an acquisition date of 1 September 2020.
Taxpayer allocates the remainder of its units of unused basis in DE to the units of DE held in Wallet B. Taxpayer has made a specific unit allocation for purposes of the revenue procedure. In 2025, Taxpayer sells two units from Wallet A. Prior to the sale, Taxpayer may specifically identify the two units sold from among the four units allocated to Wallet A in its specific unit allocation.
Global allocation
A global allocation involves allocating units of unused basis based on a rule prescribing the manner by which units of unused basis will be ordered and then allocated to a pool of remaining digital asset units within each wallet or account.
Example: The facts are the same as the example above, except Taxpayer does not make a specific unit allocation. Instead, before 1 January 2025, Taxpayer describes an ordering rule in its books and records that identifies and orders the units of unused basis based first on the highest basis units and second on the units with the earliest acquisition dates. The ordering rule also directs that these ordered units of unused basis will be allocated first to the remaining digital asset units in Wallet A, and then to the remaining digital asset units in Wallet B. The taxpayer’s rule is a global allocation. The global allocation results in the four units of DE in Wallet A being first allocated the highest units of basis, which are four of the 20 units of unused basis of USD 5 acquired on 1 September 2020. Sixteen of the 20 units of DE held in Wallet B are allocated the remaining 16 units of unused basis of USD 5, and then four of the remaining digital asset units in Wallet B are allocated the four units of unused basis of USD 1 acquired on 1 July 2019.
Timing requirements for reasonable allocations
The taxpayer must complete its specific unit allocations of unused basis units to its remaining digital asset units before the earlier of (i) the date and time of the first sale or disposition of the digital asset completed on or after 1 January 2025, or (ii) either the due date (including extension) of the taxpayer’s return for the taxable year that includes 1 January 2025 or, if the taxpayer is not required to file a return for such taxable year, the last date (without extension) for filing the return for such year that would be applicable if the taxpayer were required to file a return.
A taxpayer must describe its global allocation methods in its books and records before 1 January 2025. A taxpayer making a global allocation also must complete the allocations of unused basis units to its remaining digital assets within each of its wallets or accounts before the later of the dates set forth above for completion of specific unit allocations.
Until the taxpayer has completed the allocations, the taxpayer must separately account for any acquisitions or transfers to the taxpayer of digital asset units on or after 1 January 2025 held within the same wallet or account as remaining digital asset units and units of unused basis.
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