Proposed Regulations on Digital Asset Transactions: What You Need to Know

On Friday, August 25th, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) unveiled a series of proposed regulations (REG-122793-19 / IRS 2023-17565) addressing income taxation and reporting nuances in the digital asset domain. These proposed regulations signal much needed and anticipated guidance regarding the income taxation and reporting of digital asset transactions and for some major players within the field, such as brokers and exchanges. It appears the IRS also wanted to provide taxpayers and tax advisors with some fun summer reading over the weekend, as it has done in recent years.

Income Tax and Reporting Topics Covered within the Proposed Regs

The proposed regs cover:

• Information reporting, determining the amount realized and basis, and backup withholding for certain digital asset sales and exchanges.
• A requirement for real estate reporting persons, who are treated as brokers with respect to reportable real estate transactions, to include on filed information returns and furnished payee statements the fair market value of digital asset consideration received by real estate sellers in reportable real estate transactions.
• The requirement that real estate reporting persons would also be required to file information returns and furnish payee statements for real estate purchasers who use digital assets to acquire real estate in these transactions.

The informational reporting requirements for brokers, including digital asset trading platforms, digital asset payment processors, and certain digital asset hosted wallets, on dispositions of digital assets effected for customers in some sale or exchange transactions should help ease the burden of reporting corresponding information on tax returns for both the taxpayer and tax return preparer.

In a consistent and somewhat predictive manner, the IRS applies existing income tax rules to (1) the gain or loss recognized in a sale, conversion, or exchange transaction and (2) cost basis, although noting that there are no specific regulations for computing cost basis for digital assets or crypto.

TAX CONSIDERATIONS: WHAT IT MEANS FOR TAXPAYERS

These Proposed Regulations are not tax law; there is a comment period, and final regulations may be closely aligned or differ from these Proposed Regulations. Second, the government clarifies that these proposed regulations are not securities (SEC) or commodities (CFTC) rules or a corollary. Finally, these proposed regulations should provide relevant players with some clarity on the IRS’ current view on the income tax treatment and reporting requirements for certain digital asset transactions. Thus, taxpayers should consider preparing to take the first steps for income tax planning and compliance/reporting for digital asset transactions. These preliminary steps should include understanding informational reporting obligations and resulting income tax liability from certain digital asset transactions and information gathering to comply with potentially required tax reporting.

CONCLUSION

The flood of crypto tax developments in July and August of 2023 promises greater clarity and guidance from the IRS on income tax issues stemming from digital asset transactions and for the players involved within the space. With more clarity comes greater responsibility for taxpayers, exchanges, brokers, tax return preparers, and tax advisors to comply with income tax law and guidance.

Note: The terms crypto, cryptocurrency, digital assets, tokens, and digital currency are used interchangeably.