What is the action cryptocurrency investors need to take immediately? What has changed, and why should any digital asset holder or investor pay attention to this game-changing development?
Here is the short answer: If you don’t take action, you will pay substantially more tax than you otherwise should on every one of your existing digital assets.
The U.S. Department of the Treasury and the IRS just announced the finalization of the IRS digital asset broker reporting requirements. The Bipartisan Infrastructure Investment and Jobs Act (IIJA) took effect late in 2021, and a central issue addressed in the new law relates to international reporting requirements and taxation upon all digital assets (including cryptocurrencies and Non-Fungible Tokens or NFTs).
The IRS has been trying to gain insight and reporting access to digital asset exchanges and dealers worldwide. Here is what you need to know and the action cryptocurrency investors need to take immediately:
- You have until the end of 2024 to set a reasonable “basis” on all of your digital currency (the basis is basically the “cost” of an asset that will determine whether any subsequent transaction results in a capital gain or loss and the amount of the profit or loss). If you fail to establish a reasonably allocated basis, the IRS will presume your basis is ZERO on all of your digital assets beginning January 1, 2025. If the basis of a digital asset one is selling or trading is $0.00, then the entire sales price or valuation of the asset at the time of the transaction is to be taxed as a capital gain (short or long-term), in other words, 100% profit.
- The tax applies to each “wallet” or “account,” not individual digital assets. Therefore, U.S. taxpayers must assign the basis for each digital currency wallet or account before 1/1/2025.
- Present tax preparation software often blends the average basis from the combination of all of your investments in order to calculate taxable capital gains (and losses). Beginning 1/1/2025, the basis of each of your digital assets must be “specific to the wallet or account.” If you are unable to prove the basis of each asset or establish the basis of each wallet or account before the deadline, the IRS will legally consider your initial cost (basis) to be $0.
- U.S. taxpayers with digital assets are still required to record and report all digital activity to the IRS, including basis. It is important to note that the IRS will receive huge amounts of data specific to U.S. taxpayers (including taxpayer social security number or TIN) from digital asset brokers and exchanges worldwide beginning January 1, 2025. The IRS will be comparing the reports of each taxpayer with the information received worldwide through Artificial Intelligence (AI) apps. If the information isn’t a match, prepare for an investigation or IRS audit.
The IRS recently released Revenue Procedure 2024-28 (Rev. Proc. 2024-28) that may help U.S. digital asset investors to understand the IRS’ “safe harbor,” as well as the process for basis allocation of existing digital assets to specific wallets or accounts by the 1/1/2025 deadline. The concept of averaging your entire digital asset portfolio (sometimes referred to as the “universal wallet approach”) has come to an end. This complex guide provides specific instructions on the transition to a wallet-based or account-based basis.
U.S. taxpayers with digital assets will be required to maintain detailed financial records beginning January 1, 2025. These records must include the following information for each “digital asset unit”:
- Date of acquisition
- Purchase Price or Exchange Value
- Number of units remaining in each wallet or account
The allocation of basis to specific wallets and accounts is an action cryptocurrency investors need to take immediately in order to comply with the January 1, 2025 deadline. The failure to comply with the IRS requirements laid out in Revenue Procedure 2024-28 will substantially increase the amount of taxes owed upon any subsequent sale, transfer, or trade of existing digital assets. The IRS will assign a basis of $0 to all existing digital asset units [in your wallet(s) or account(s) on 1/1/2025], substantially increasing the taxable profit of every digital asset transaction, trade, or transfer.
The failure to accurately report your activities and the basis of your digital asset transactions exposes the U.S. taxpayer to IRS investigation, audit, additional taxes, penalties, and interest, as well as the risk of criminal exposure for tax evasion.
The establishment of a basis for each wallet or account (Specific Unit Allocation) for existing digital asset units is the action cryptocurrency investors need to take immediately.
Janathan Allen is a domestic and international tax attorney with decades of experience. Time is of the essence. If you need advice or assistance with the allocation of basis or tax issues associated with your digital asset portfolio we invite you to download our Cryptocurrency Reporting Guide, and learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.