IRS Finalizes Digital Asset Reporting Regulations: What Brokers and Investors Need to Know
On June 28, 2024, the Internal Revenue Service (“IRS”) and the Treasury Department issued final regulations and other guidance related to reporting digital assets. Beginning with the 2025 calendar year, brokers may be required to report certain information regarding digital asset transactions as outlined in the new regulations set forth by the IRS. This includes filing information returns, providing statements to payees, and withholding on certain digital asset transactions.
Under Section 6045(c), a broker is defined to include a dealer, a barter exchange, any person who regularly acts as a middleman with respect to property or services in exchange for consideration, and any person who is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person in exchange for consideration.
Affected Brokers and Their Reporting Requirements
The new reporting requirements apply to brokers who take possession of their clients’ digital assets that their customers are selling. This includes operators of custodial digital asset trading platforms, certain digital asset-hosted wallet providers, digital asset kiosks, and certain processors of digital asset payments. These custodial brokers will use Form 1099-DA Digital Asset Proceeds from Broker Transactions to report the required information. No additional reporting requirements have been outlined in these regulations for brokers that do not take possession of their clients’ digital assets. Any reporting requirements for these non-custodial types of brokers will be outlined in a different set of regulations issued by the IRS.
The final regulations require that brokers report the gross proceeds, date and time of the transactions, number of units transferred, and, in some instances, the adjusted basis for the digital asset transaction on the information return and payee statements. Under the proposed regulations, the transaction ID and digital asset address were also required to be reported. However, after the IRS and Treasury Department received feedback that providing this information created privacy and surveillance concerns, it was decided to remove these items from the brokers’ reporting obligations. As this information would still be helpful for visibility purposes in the event of an audit, the IRS and Treasury Department have required that brokers keep this information in their records for seven years from the due date of the related information return filing.
The new digital asset regulations will also impact real estate professionals. In addition to reporting on dispositions of digital assets in exchange for real estate by buyers, the rules also require reporting on any digital assets received by real estate sellers. Real estate professionals must report the fair market value of the exchanged digital assets for any transaction that closes on or after January 1, 2026.
As the IRS and Treasury Department issued these reporting requirements and guidelines, certain transactions in the digital asset space have been excluded, and additional time is required to determine an appropriate reporting method for these types of transactions. Notice 2024-57 states that brokers will not have to report the following transactions on their informational returns:
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Potential Challenges
Brokers may need help with complying with these newly imposed filing requirements. When the digital asset transaction falls under a digital asset sale for cash, a broker may find it challenging to obtain the proper tax documentation from customers or to develop adequate systems. When the transaction is a sale of a digital asset in exchange for a different digital asset, a broker may find it challenging to create the logistics and processes related to withholding. For instance, the price of digital assets received may fluctuate between the transaction time and when the received digital assets are liquidated into cash for deposit with the Treasury Department. Additionally, in the case of a sale of digital assets in exchange for other property, a broker may not be able to withhold because the property received is illiquid, such as goods, services, or real estate. The IRS recognizes the severity of the challenges brokers may face and is taking a phase-in approach to these requirements by outlining the relief available to brokers in Notice 2024-56.
Imposed Penalties and Available Relief
Under Sections 6721 and 6722, penalties may be imposed for failing to file an information return or furnish a payee statement on or before their respective due dates, as well as for failing to include all information required to be reported on these forms (including incorrect information).
The IRS recognizes the challenges associated with implementing the new reporting requirements and is providing transitional and penalty relief regarding penalties assessed on reporting and backup withholding obligations. Notice 2024-56 indicates that, under Section 6724, no penalty will be imposed under Sections 6721 and 6722 if the failure was due to reasonable cause and not willful neglect. The notice also provides transitional relief for penalties imposed on backup withholding requirements.
As the digital asset world grows in new and unregulated territory, new regulations have been issued to provide additional guidance on the reporting requirements. As guidance and changes in reporting requirements are still developing, it is essential to be mindful and stay up to date, as the tax law is complex. Should you need assistance interpreting these changes in tax law and understanding the new reporting requirement, please contact your Marcum professional.
By Francesco Quaranta, CPA, Tax Senior Manager, Alternative Investment Group