IRS Issues Proposed Regulations on Broker Reporting of Digital Asset Transactions

(Parker Tax Publishing September 2023)

The IRS issued proposed regulations that require brokers, including digital asset trading platforms, digital asset payment processors, and certain digital asset hosted wallet providers, to report gross proceeds from sales and exchanges of digital assets by customers that take place on or after January 1, 2025, on new Form 1099-DA and to provide payee statements to customers. The proposed regulations also require real estate reporting persons, to report the disposition of digital assets paid as consideration by purchasers of real estate; in addition, the proposed regulations set forth gain (or loss) computation rules, basis determination rules and backup withholding rules for digital asset sale and exchange transactions. REG-122793-19; IR-2023-153 (8/25/23).

Background

Virtual currency is defined in Notice 2014-21 for federal income tax purposes as a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value other than the U.S. dollar or a foreign currency (fiat currency). Notice 2014-21 provides guidance on the application of the current information reporting requirements when virtual currency is used to pay wages (requiring the filing of Forms W-2, Wage and Tax Statement), to make miscellaneous payments (requiring the filing of Forms 1099-MISC, Miscellaneous Income), and to settle third party network transactions (requiring the filing of Forms 1099-K, Payment Card and Third Party Network Transactions). The guidance provided by Notice 2014-21, however, focuses only on information reporting for virtual currency payments received by payees. The guidance does not address the information reporting requirements for income realized by persons who dispose of virtual currency or other digital assets.

Section 80603 of the Infrastructure Investment and Jobs Act (Infrastructure Act) (Pub. L. 117-58), enacted in 2021, made several changes to the broker reporting provisions under Code Sec. 6045 to clarify the rules regarding how certain digital asset transactions should be reported by brokers, and to expand the categories of assets for which basis reporting is required to include all digital assets. Section 80603(a) of the Infrastructure Act clarifies the definition of "broker" to include any person who, for consideration, is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. Section 80603(b)(1) of the Infrastructure Act modifies the definition of "specified securities" under Code Sec. 6045(g) to explicitly include digital assets and to provide that these specified securities are treated as covered securities for purposes of basis reporting if they are acquired on or after January 1, 2023. Section 80603(b)(1)(B) of the Infrastructure Act defines a "digital asset" broadly to mean any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology. Section 80603(b)(2) of the Infrastructure Act clarifies that transfer statement reporting under Code Sec. 6045A(a) applies to covered securities that are digital assets, and also adds a new information reporting provision under Code Sec. 6045A(d) to provide for broker reporting on transfers of digital assets that are covered securities, provided the transfer is not a sale and is not to an account maintained by a person that the broker knows or has reason to know is also a broker. Section 80603(c) of the Infrastructure Act provides that these amendments apply to returns required to be filed, and statements required to be furnished, after December 31, 2023.

On August 29, the IRS published proposed regulations in REG-122793-19 regarding information reporting, the determination of amount realized and basis, and backup withholding, for certain digital asset sales and exchanges.

Proposed Regulations

The proposed regulations extend the information reporting rules in Reg. Sec. 1.6045-1 to brokers who, in the ordinary course of a trade or business, act as agents, principals, or digital asset middlemen for others to effect sales or exchanges of digital assets for cash, broker services, or property of a type that is subject to reporting by the brokers (including different digital assets, securities, and real estate) under Code Sec. 6045 or effect on behalf of customers payments of digital assets associated with payment card and third party network transactions subject to reporting under Code Sec. 6050W. The proposed regulations also clarify that the definition of broker for purposes of Code Sec. 6045 includes digital asset trading platforms, digital asset payment processors, certain digital asset hosted wallet providers, and persons who regularly offer to redeem digital assets that were created or issued by that person.

In addition, the proposed regulations require real estate reporting persons to report on real estate purchasers who use digital assets to acquire real estate in a reportable real estate transaction and extend the information that must be reported under Reg. Sec. 1.6045-4 with respect to sellers of real estate to include the fair market value of digital assets received by sellers in exchange for real estate. Additionally, in the case of a transaction involving the exchange of digital assets for goods (other than digital assets) or services, the proposed regulations treat the provision of the goods or services as reportable under Code Sec. 6050W and the disposition of the digital assets as reportable under Prop. Reg. Sec. 1.6045-1 and not under Code Sec. 6050W. The proposed regulations also provide that exchanges of digital assets for property or services are generally not reportable as barter exchange transactions under the existing rules under Reg. Sec. 1.6045-1(e). Finally, the proposed regulations provide specific rules under Code Sec. 1001 for determining the amount realized in a sale, exchange, or other disposition of digital assets and under Code Sec. 1012 for calculating the basis of digital assets.

Observation: In the preamble to the proposed regulations, the IRS stated that it expects to make changes to broker reporting for digital assets in multiple phases. The proposed regulations issued in REG-122793-19 generally focus on changes to existing Reg. Sec. 1.6045-1 to require brokers to report on digital asset sales. Later phases will focus on implementing transfer statement reporting under Code Sec. 6045A(a) and broker information reporting under Code Sec. 6045A(d) for covered security transfers that are not transfers to accounts maintained by persons known to be brokers or subject to reporting as sales.

Under existing Reg. Sec. 1.6045-1(a)(9), brokers are generally required to file an information return for each sale effected on behalf of a customer. The proposed regulations provide that for sales or exchanges of digital assets that take place on or after January 1, 2025, reporting under Code Sec. 6045 is also required for certain dispositions of digital assets that are made in exchange for cash, different digital assets, stored-value cards, broker services, or property subject to reporting under existing Code Sec. 6045 regulations.

Definition of Digital Asset

Consistent with the definition provided in Section 80603(b)(1)(B) of the Infrastructure Act, the proposed regulations define a digital asset as a digital representation of value that is recorded on a cryptographically secured distributed ledger (or similar technology). The proposed regulations also provide that a digital asset does not include cash, for example, a fiat currency in digital form such as funds in a bank or payment processor account accessed through the Internet. In addition, under the proposed regulations, the determination of whether an asset is a digital asset is made without regard to whether each individual transaction involving that digital asset is actually recorded on the cryptographically secured distributed ledger. The IRS noted that the use of cryptography, through the use of public and private keys to transfer assets, distinguishes digital assets as defined by the Infrastructure Act from other virtual assets and is therefore an essential part of the definition.

Information Required to Be Reported on New Form 1099-DA

The IRS noted in a press release (IR-2023-153) that digital asset transactions will be reported on new Form 1099-DA, Digital Assets. The proposed regulations provide that for each digital asset sale for which a broker is required to file an information return, the broker must report on Form 1099-DA the following information:

(1) The customer's name, address, and taxpayer identification number;

(2) The name or type of the digital asset sold and the number of units of the digital asset sold;

(3) The sale date and time;

(4) The gross proceeds of the sale; and

(5) Any other information required by the form or instructions.

In addition, to aid the IRS in verifying valuations provided for reported gross proceeds and in determining whether the basis claimed by taxpayers in connection with transactions for which adjusted basis information is not reported by the broker, Prop. Reg. Sec. 1.6045-1(d)(2)(i)(B) also requires the broker to report:

(1) The transaction identification (transaction ID or transaction hash) associated with the digital asset sale, if any;

(2) The digital asset address (or digital asset addresses if multiple) from which the digital asset was transferred in connection with the sale, if any; and

(3) Whether the consideration received was cash, different digital assets, other property, or services.

Expansion of the Types of Sales Subject to Reporting

According to the IRS, digital assets are unique among the types of assets that are subject to reporting under Code Sec. 6045 because it is common for digital assets to be exchanged for different digital assets. In addition, some digital assets can readily function as a payment method as well as an investment asset. Digital assets can be exchanged for cash, stored-value cards, services, or other property (including different digital assets).

To avoid gaps in information reporting with respect to this broad range of taxable exchanges, Prop. Reg. Sec. 1.6045-1(a)(9)(ii) expands the definition of a sale subject to reporting. Prop. Reg. Sec. 1.6045-1(a)(9)(ii)(A)(1) and (2) provide that a sale includes the disposition of a digital asset in exchange for cash, one or more stored-value cards, or a different digital asset. An exchange for cash for these purposes includes a payment received through the use of a check, credit card, or debit card. Prop. Reg. Sec. 1.6045-1(a)(25) defines a stored-value card as a card - whether in physical or digital form - with a prepaid value in U.S. dollars, any convertible foreign currency, or any digital asset. A stored-value card includes a gift card. The IRS requested comments on whether the types of consideration for which digital assets may be exchanged in a sale transaction is sufficiently broad to capture current and anticipated transactions in which taxpayers regularly dispose of digital assets for consideration.

Prop. Reg. Sec. 1.6045-1(a)(9)(ii)(B) provides that a sale of a digital asset includes the disposition of a digital asset by a customer in exchange for property (including securities and real property) of a type that is subject to reporting under Code Sec. 6045. Thus, for example, if a stockbroker accepts a digital asset from a customer as payment for the customer's purchase of stock, that disposition of the digital asset in exchange for stock will be treated as a sale of the digital asset by that customer for purposes of Code Sec. 6045. Similarly, if a real estate reporting person, as defined in existing Reg. Sec. 1.6045-4(e), is involved in a real estate transaction in which the real estate buyer uses digital assets as consideration in the exchange for real property, that disposition of digital assets in exchange for real property will be treated as a sale of the digital assets by that real estate buyer for purposes of Code Sec. 6045.

Further, in view of the increasing use of digital assets to make payments for goods and services or to satisfy other payment obligations through the intermediation of digital asset payment processors, Prop. Reg. Sec. 1.6045-1(a)(9)(ii)(D) provides that a sale includes payments of a digital asset by the customer to a digital asset payment processor in exchange for that processor's payment of a different digital asset or cash to a second person. A sale also includes the transfer of a digital asset by a customer directly to a second person (such as a vendor of goods or services) pursuant to a processor agreement that provides for the temporary fixing of the exchange rate to be applied to the digital asset received by the second person, which is treated (under the rules setting forth the definition of a digital asset payment processor) as if the digital asset was paid by the customer to the digital asset payment processor in exchange for a different digital asset or cash paid to that second person.

For a discussion of sales, exchanges, or other dispositions of virtual currency, see Parker Tax ¶119,610. For a discussion of broker information reporting requirements, see Parker Tax 116,180.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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