IRS Rules on Digital Assets
This article explores the classification of digital assets as property, the capital gains tax treatment, new reporting requirements for brokers, and the challenges faced by both taxpayers and the IRS in this rapidly changing landscape.
Contents
The Internal Revenue Service (IRS) has been grappling with the taxation of digital assets, particularly cryptocurrencies, since their emergence as a significant economic force over the past decade. As these novel forms of value continue to reshape the financial landscape, the IRS has been working to clarify its position and establish comprehensive guidelines for taxpayers. The journey began in 2014 with the issuance of Notice 2014-21, which laid the groundwork for treating virtual currencies as property for federal tax purposes. Since then, the IRS has expanded its guidance, introduced new reporting requirements, and most recently, released final regulations implementing the bipartisan Infrastructure Investment and Jobs Act (IIJA) provisions related to digital asset transactions. These developments reflect the government’s ongoing efforts to adapt tax policy to the digital age, balancing the need for clear rules with the challenges posed by the rapidly evolving nature of blockchain technology and cryptocurrency markets.
IRS Classification of Digital Assets
The IRS classifies digital assets, including cryptocurrencies, as property for federal tax purposes. This classification has significant implications for taxpayers:
- Capital Asset Treatment: When held as a capital asset, digital assets are subject to capital gains tax rules.
- Taxable Events: Selling, trading, or using digital assets to pay for goods or services can trigger taxable events.
- Fair Market Value: The fair market value of the digital asset in U.S. dollars at the time of the transaction determines the tax basis.
Capital Gains on Digital Asset Sales
The IRS ruling regarding capital gains on the sale of digital assets, including cryptocurrencies, follows these general principles:
- Holding Period:
- Short-term: Assets held for one year or less are taxed as ordinary income.
- Long-term: Assets held for more than one year qualify for preferential capital gains tax rates.
- Tax Rates:
- Short-term gains are taxed at the taxpayer’s ordinary income tax rate.
- Long-term gains are taxed at 0%, 15%, or 20%, depending on the taxpayer’s income bracket.
- Cost Basis: The original purchase price plus any transaction fees determines the cost basis.
- Calculation: Capital gain (or loss) is the difference between the sales price and the cost basis.
New Reporting Requirements
The IIJA introduced new reporting requirements for digital asset brokers:
- Timeline:
- Starting in 2026 for transactions in 2025: Brokers must report gross proceeds from digital asset sales.
- Starting in 2027 for transactions in 2026: Brokers must also report information on the tax basis for certain digital assets.
- Form 1099-DA: A new form specifically designed for reporting digital asset transactions.
- Scope: Includes custodial brokers, with potential expansion to non-custodial brokers in future regulations.
Taxpayer Responsibilities
- Reporting All Transactions: Taxpayers must report all digital asset transactions, regardless of size.
- Form 8949: Used to report capital gains and losses from digital asset transactions.
- Schedule D: Summarizes the information from Form 8949 on the taxpayer’s Form 1040.
- FBAR Reporting: Foreign-held digital assets may need to be reported on FinCEN Form 114.