Tuesday, February 13, 2024

Important Effective Date Item in Preamble to Digital Asset Broker Reporting Prop. Regs.

stacks of coins to represent bitcoin
The proposed regulations on broker reporting of digital assets released August 29, 2023 (REG-122793-19) included more than guidance under IRC section 6045. They also included related proposed regulations under section 1001 on amount realized and section 1012 on basis. I think that generally, the 1001 and 1012 proposed regulations are fairly straightforward and tie to the general rules at these provisions.  

One clarification they offer is that in a transaction where a taxpayer exchanges, for example, X coin for Y coin and pays a transaction fee, 50% of the transaction fee is treated as a reduction to the amount realized for the disposition of X coin and 50% is added to the basis of the Y coin acquired.

Unlike the virtual currency FAQs #39 - #41, Prop. Reg. 1.1012-1(j) provides that in applying the specific identification method to know which digital asset was disposed of (when the taxpayer has more than one unit or code representing their digital assets), the taxpayer must apply specific identification on a wallet by wallet or exchange by exchange system. In contrast, the FAQs allow (or at least do not disallow) use of a universal tracking approach where the taxpayer transferring, for example, 2 Xcoin out of wallet 1 to buy goods, could specifically identify to say they used the basis of 2 Xcoin in T's wallet 2. This would not be allowed under the proposed regulations. The long list of questions in the proposed regulations include though, whether there are alternatives to this approach (questions 44 & 45 at page 59616 in the Fed. Register).

Prop. Reg. 1.1001-7(c) and 1.1012-1(j)(6) provide that these proposed regulations are effective on the January 1 following when final regulations are published. However, page 59616 in the Fed. Register states that the 1001/1012 proposed regulations are reliance regulations. That is, per the preamble, taxpayers "may rely on these proposed regulations under sections 1001 and 1012 for dispositions in taxable years ending on or after August 29, 2023, provided the taxpayer consistently follows the proposed regulations under sections 1001 and 1012 in their entirety and in a consistent manner for all taxable years through the applicability date of the final regulations."

Since the broker reporting regs under section 6045 won't be effective for reporting of gross proceeds until sales on or after January 1, 2025 (basis reporting for sales on or after January 1, 2026), if a taxpayer follows the date of the proposed 1001/1012 regulations starting for 2023, they would also do so for 2024.

But, I don't think most taxpayers can follow the 1001/1012 proposed regulations until the 6045 regulations are effective because taxpayers might not be able to get the exchanges they use to help them with the specific identification called for in the proposed regulations.

But, practitioners need to present the effective date choice to clients because the decision is theirs to make. But before making it they should check if any exchange they use will allow them to specifically identify the digital asset they are transferring at the time of the transfer and document that for them (and apply FIFO if they do not give the exchange specific identification information at the time of a transfer). For unhosted wallets, the taxpayer handles that specific identification on their own, likely by sending themselves an email to document what they are doing and have the date verification from the email.

Also, would be a good idea to let your client know that the final regulations might have a different approach then tracking basis wallet by wallet and exchange by exchange. 

Not sure why the 1001/1012 proposed regulations were offered as reliance regs when there are reasons it is either impossible or unwise for taxpayers to start applying them for 2023 and 2024. Also, given the latitude in the virtual currency FAQs, if a taxpayer were tracking on a universal approach, they should be able to change going forward to wallet by wallet and exchange by exchange (with no need to get help from the exchange for that until the regs are finalized). The IRS notes in the preamble to the regs 
(page 59611 of the Federal Register) and at Prop. Reg. 1.1012-1(j)(4) that such a change is not a method of accounting as the method is still specific identification.

So, something to think about and find a way to present to your clients with digital assets so they can make the decision the IRS offers all taxpayers regarding the effective date of the 1001 and 1012 proposed regulations.

What do you think?

No comments:

Post a Comment