On August 29, 2023, the Department of the Treasury and the Internal Revenue Service (“IRS”) published proposed regulations that, if finalized, would require brokers (including digital asset trading platforms, digital asset payment processors, and certain digital asset hosted wallets) to report sales and exchanges of digital assets by customers. This client alert highlights key provisions of the proposed regulations that will be particularly impactful on our clients.
Under Internal Revenue Code (“IRC”) Section 6045, brokers are generally required to file informational returns showing gross proceeds, tax basis, gain or loss information, and the long-term or short-term capital gain treatment of such gain or loss on the sales of certain property effected through the broker by their customers. The Infrastructure and Jobs Act of 2021 expanded the definition of “broker” under IRC Section 6045 to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person” and expanded the definition of “covered security” to include digital assets acquired on or after January 1, 2023. The proposed regulations provide much needed clarity to the determination of who is a broker of digital assets and provide rules for gross proceeds, tax basis, and capital gain reporting by brokers.
Who is a Broker?
The proposed regulations under IRC Section 6045 retain the existing definition of a “broker” as any person that, in the ordinary course of a trade or business, effects sales to be made, but revise the definition of “effect” to include a person acting as a digital asset middleman for a sale of digital assets. A digital asset middleman is a person that “knows or is in a position to know the identity of the party that makes the sale and the nature of the transaction potentially giving rise to gross proceeds from the sale.” Treasury makes clear that a party “in the position to know” means a party with the ability to modify the operation of a platform to obtain customer information.
Therefore, under the proposed regulations, the definition of broker would include digital asset trading platforms, digital asset payment processors, certain digital hosted wallet providers, operators and owners of digital asset kiosks, and persons who regularly offer to redeem digital assets that they issued or created.
What is a Digital Asset?
The proposed regulations define a “digital asset” as “any digital representation of value that is recorded on a cryptographically-secured distributed ledger (or any similar technology), without regard to whether each individual transaction involving that digital asset is actually recorded on that ledger, and that is not cash.” This includes non-fungible tokens (NFTs) and stablecoins.
Under the proposed regulations, sales or exchanges of digital assets that take place on or after January 1, 2025 will require brokers to report gross proceeds to the IRS on a newly developed Form 1099-DA and to provide similar statements to their customers. Furthermore, brokers will be required to report gain or loss and basis information for sales that take place on or after January 1, 2026, on Form 1099-DA, as well as to their customers on a corollary statement. Additionally, the proposed regulations would require reporting on real estate purchasers who use digital assets to acquire real estate in a reportable transaction under Treasury Regulation Section 1.6045-4. Finally, the proposed regulations require reporting in the case of transactions involving the exchange of digital assets for goods or services.
For digital assets sales that brokers are required to file an information return, brokers must report the following information:
- The customer’s name, address, and taxpayer identification number;
- The name or type of the digital asset sold and the number of units of the digital asset sold;
- The sale date and time;
- The gross proceeds of the sale; and
- Any other information required by the relevant form or instructions.
In addition, depending on the type of sale, brokers might be required to report the transaction identification associated with the digital asset sale, if any, the digital asset address from which the digital asset was transferred in connection with the sale, if any, and whether the consideration received was cash, different digital assets or other property, or services.
Determination of Basis and Gross Proceeds
Because the proposed regulations provide a requirement of the reporting of basis and gross proceeds on the sale or exchange of digital assets, they also provide the rules for determining basis and gross proceeds under IRC Sections 1012 and 1001, respectively, which generally allow for digital transaction costs to be taken into account for such transactions. Proposed Treasury Regulation Section 1.1001-7(b) describes the computation for gross proceeds as the sum of (i) the amount of cash received, (ii) the fair market value of any property received, and (iii) the fair market value of any services received, including services giving rise to digital asset transaction costs, less any allocable digital asset transaction costs. Basis in a digital asset, determined under Proposed Treasury Regulation Section 1.1012-1(h), is equal to the cost of the digital asset at the date and time of the purchase or exchange, plus any allocable digital asset transaction costs to such asset.
Treasury and the IRS have requested comments, including on 51 specific questions, by October 30, 2023, and a public hearing on the proposed regulations is scheduled for November 7, 2023. Until the regulations are final, however, the proposed regulations provide a basic framework for anticipating the coming regulatory and reporting scheme that will be applicable to digital assets and related transactions.