- The proposed regulations under the Infrastructure Investment and Jobs Act (IIJA) expand the definition of “broker” to include anyone who provides facilitative services which effectuate sales.
- Not surprisingly, centralized exchanges were included as digital asset “brokers,” while crypto miners and stakers were not. Unclear is the treatment of digital asset wallet providers and decentralized financial protocols. Seemingly, the distinction for these last two will be based on the degree of autonomy, or lack of human oversight.
- The proposed regulations would require a broad range of transactions to be reported, including those not currently reported and occurring on a public blockchain.
On August 25, 2023, the Internal Revenue Service (IRS) published proposed regulations [REG-122793-19] in the Federal Register, clarifying requirements under the Infrastructure Investment and Jobs Act (IIJA). The IIJA was enacted almost two years ago in November 2021, and established digital asset transaction reporting requirements addressing who is specifically responsible for furnishing information to the IRS and cryptocurrency customers for digital asset transactions. The act included definitions for digital assets and “digital asset brokers,” the latter of which was concerningly broad in scope. Clarifying follow-up regulations have been arguably slow in coming.
This newly released guidance addresses some of the required information reporting for certain digital asset sales or exchanges, specifically covering the determination of amount realized and tax basis, along with the applicability of backup withholding. These proposed regulations focus on incorporating the complexities of digital assets into the reporting framework for brokers under Treasury Regulation 1.6045-1.
Expansion of Information Reporting Requirements under Treasury Regulation 1.6045-1
The proposed regulations would provide for Treasury Regulation 1.6045-1 to be expanded to include sales of digital assets. The proposed regulations clarify that digital asset “brokers” include any person providing facilitative services to effectuate the sales of digital assets by customers, provided that the nature of the person’s service arrangement with customers is such that the person would know, or be in a position to know, the identity of the party making the sale and the nature of the transaction giving rise to possible gross proceeds. The definition of effect would include digital asset issuers, dealers and middlemen as brokers. Middlemen are persons who ordinarily know the nature of the transaction by means of facilitating it, know the gross proceeds of the transaction, or could charge a fee for services provided. The definition of facilitative services is fairly broad and includes direct and indirect services that bring about the sale, exchange or other disposition of a digital asset.
This expansion is significant because brokers under Internal Revenue Code section 6045 are required to submit information returns on covered transactions, which now include digital asset transactions.
The digital asset transactions covered under the proposed regulations include, but are not limited to, the following:
- A disposition of a digital asset for cash or gift cards,
- An exchange of a digital asset for another digital asset,
- Receipt of a digital asset as settlement for a forward contract,
- A disposition of a digital asset in exchange for real property,
- A disposition of a digital asset effectuated through a digital wallet, and
- A disposition of a digital asset to a payment processor to be sent to another party.
Importantly, transactions that are generally only recorded on a broker’s internal ledger are still covered by the proposed regulations.
Determining Amount Realized and Tax Basis for Digital Asset Sales, Exchanges or Other Dispositions
The proposed regulations would define the amount realized from the sale or disposition of a digital asset as the sum of the total U.S. dollars paid for the asset, plus the fair market value of any additional property or services received, reduced by any transactional costs incurred. The proposed regulations call for taxpayers to use a reasonable valuation method which considers a number of factors, including trading volumes. The transactional costs include transfer taxes, commissions and other fees incurred to cause the sale to be completed.
Further clarified is that in the case of digital assets purchased for cash, the adjusted basis is the total cash paid, increased by any commissions fees, transfer taxes and transaction costs incurred. In the case of digital assets purchased in exchange for property, the adjusted basis is the fair market value at the time of the exchange increased by any transaction costs.
These rules will apply to sales and other dispositions of digital assets in the calendar year immediately following the publication date of the final regulations. It further provides that taxpayers can only rely on the proposed regulations for sales occurring in taxable years on or after August 29, 2023, up to the publication date of the final regulations and thereafter.
Missing from This Guidance
Missing from the proposed regulations is any mention of a Form 1099-DA, a digital asset-specific information return that has been alluded to previously by the Internal Revenue Service.
These proposed regulations provide guidance crucial to many operating in this arena on the reporting requirements discussed in the IIJA. While not as detailed as some had perhaps hoped, the new rules do provide important guidelines for industry participants aiming to remain legally compliant. Importantly, the definition of “broker” under these new proposed regulations is not unfairly all encompassing.