IRS Releases Proposed Regulations on Digital Asset Transaction Reporting

By: David L. Forst , Sean P. McElroy , Kevin Kirby , Matthew L. Dimon

On Friday, August 25, 2023, the U.S. Treasury Department (Treasury) released proposed regulations interpreting the broker reporting rules for digital assets that were part of the 2021 Infrastructure Investment and Jobs Act (the Infrastructure Act). The proposed regulations address the treatment of gross proceeds and basis reporting by brokers in digital assets as well as the determination of amount realized and basis for digital asset transactions. These proposed regulations, if finalized in the current form, will have a material effect on the entire digital asset community. Treasury has requested comments to these proposed regulations, including 51 specific questions.

We outline some of the key provisions below:

The proposed regulations extend the information reporting rules in § 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. The proposed § 1.6045-1 regulations require “brokers” to report the gross proceeds starting for sales and exchanges of “digital assets” effected on or after January 1, 2025, though several of the proposed sections have rules that can, in certain cases, be applicable before 2025.

The term “broker” is defined as a person who, in the ordinary course of a trade or business during the calendar year, stands ready to effect sales to be made by others. This includes obligors who issue and retire debt obligations, corporations that regularly redeem their own stock, a person who regularly offers to redeem digital assets that were created or issued by that person, and real estate reporting persons. For sales effected at an office outside of the United States, the term “broker” includes only a person described as a U.S. payor or U.S. middleman described in Treas. Reg. § 1.6049-5(c)(5).

“Digital asset” is defined in Proposed Treas. Reg. § 1.6045-1(a)(19) 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.” Treasury notes in its Preamble that the “use of cryptography, through the use of public and private keys to transfer assets [is] an essential part of the definition [of digital assets].”

The proposed regulations expand the meaning of “effect” within the definition of broker. Existing final regulations state that a person is a broker if such person stands ready to effect sales made by others. And under existing final regulations, a person effects sales if a person is an agent for a party in a sale such that the agent ordinarily would know the gross proceeds from the sale.

The proposed regulations, however, state that a person can effect the transaction (and thus be a broker) if such person “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.” This “in a position to know” standard represents a departure from the usual “knows or has reason to know” standard used in other parts of the Code and regulations relating to reporting. According to Treasury, “[t]he ability to modify the operation of a platform to obtain customer information is treated as being in a position to know that information. The Treasury Department and the IRS expect that this clarified proposed definition will ultimately require operators of some platforms generally referred to as decentralized exchanges to collect customer information and report sales information about their customers, if those operators otherwise qualify as brokers.” Treasury has explicitly stated its intent for these rules to apply to some set of decentralized finance platforms. The Preamble likens these proposed rules to the standard recommended by the Financial Action Task Force for determining whether a person is a "virtual asset service provider" with anti-money laundering obligations.

Prop. Treas. Reg. § 1.1001-7 describes the computation of gain or loss for digital assets. An amount realized in the sale or exchange of digital assets under Prop. Treas. Reg. § 1.1001-7(b) is calculated in the following manner:

  • The sum of (1) any cash received, (2) the fair market value of any property received or, in the case of a debt instrument, the issue price of such instrument, and (3) the fair market value of any services received;
  • Minus the amount of “digital transaction costs” allocated to the sale or disposition, defined as the amount paid in cash or property (including digital assets) to effect the disposition or acquisition of a digital asset.

The basis of digital assets determined under Prop. Treas. Reg. § 1.1012-1(h) is equal to the cost thereof at the date and time of the purchase or exchange, plus any allocable digital asset transaction costs to such assets. However, where digital assets are exchanged for other digital assets, one-half of the total digital asset transaction costs paid by the taxpayer is allocable to the disposition of the transferred digital assets for purposes of determining the amount realized under Prop. Treas. Reg. § 1.1001-7(b)(1). The other half of such costs is allocable to the acquisition of the digital assets for purposes of determining the basis of such digital assets. No other allocation or specific assignment of transaction costs is allowed.