The 2024 calendar year has brought with it major milestones and new regulatory considerations for cryptocurrency investors. Among those milestone events are Bitcoin surpassing $100,000 per BTC and achieving a new all-time high price. However, amidst the exciting price growth of Bitcoin and other digital assets, the IRS and other regulatory authorities have been working on new frameworks and changes to the taxation of digital currencies. The most notable change buried in the news of 2024 was the announcement by the IRS of a new draft Form 1099-DA and the release of subsequent guidance in the form of Revenue Procedure 2024-28. These two new developments carry key tax planning considerations for holders of crypto assets that taxpayers need to act on before January 1st, 2025. Further details on what these changes mean and what actions need to be taken are summarized below.
To better understand the intended purpose behind these changes, a brief history lesson on the taxation of digital assets (i.e. tokens, cryptocurrencies, and NFTs) helps establish the current reporting gap faced by the IRS, which it is attempting to address.
In short, the taxation of crypto assets generally follows the same rules as other types of "listed property" such as stocks. However, there is one distinguishing feature of crypto assets that makes the application of traditional tax treatments imperfect. In particular, the decentralized nature of crypto assets means that users of cryptocurrencies can freely move assets from one location to another (i.e. transferring 1 Bitcoin from Coinbase to Kraken). Due to this functionality, crypto tax reporting differs quite a bit from reporting gains and losses for stock investments. This key difference is further illustrated in a hypothetical example below.
Suppose that an investor purchases one share of stock in Banana, Inc. on January 1st of 2024 for $100 using Robinhood as its exchange for the transaction. The investor later sells a single share of Banana, Inc. on June 1st 2024 for $200 in its Robinhood account.
In this simple example, Robinhood has all of the pertinent information it needs to accurately issue a tax form to its users for 2024. In particular, Robinhood knows the following:
1. When the stock was purchased (which is needed to determine the holding period of the investment as either short-term or long-term).
2. What price the stock was purchased for
3. When the stock was sold (again, for determining the holding period of the investment)
4. What price the stock was sold for
With these four pieces of information, Robinhood has the information needed to issue a Form 1099-B to its user, which makes tax reporting relatively straight forward for an investor. However, where this deviates in the crypto industry is that users often do not use a single exchange when transacting in crypto. Continuing with this hypothetical example, this difference might look like this:
Suppose that an investor purchases one share of stock in Banana, Inc. on January 1st of 2024 for $100 using Robinhood as its exchange for the transaction. Instead of the investor selling their single share of Banana, Inc. on June 1st of 2024 (when it was worth $200 per share) in its Robinhood account, the investor decides to instead transfer her share of Banana, Inc. to her E-Trade account on June 1st, 2024. The investor then later sells the share of Banana, Inc. in her E-Trade account on 10/1/2024 for $300.
If you recall, the exchange, (E-Trade) needs certain information from the taxpayer to accurately provide her a Form 1099-B.
1. When the stock was purchased (which is needed to determine the holding period of the investment as either short-term or long-term).
2. What price the stock was purchased for
3. When the stock was sold (again, for determining the holding period of the investment)
4. What price the stock was sold for
From E-Trade's perspective, they only know the information from 3-4 above. E-Trade does not know 1-2 because the asset was not purchased using E-Trade. Instead, the initial purchase transaction happened at Robinhood. Therefore, because the information Robinhood has (i.e. the purchase date and purchase price) is not known to E-Trade, nor is it shared with E-Trade when an asset is transferred from one account to another, it cannot accurately issue a 1099-B to its user.
For the reasons described above, the IRS has historically relied upon crypto users to self-report their taxable amounts of the taxable crypto activities in a tax year. Further, taxpayers were permitted to use a "universal" allocation methodology that ignored the actual physical location (i.e. wallet or exchange) where an asset was held. In other words, users could use the cost basis amount of Bitcoin purchased at Coinbase when determining the gain or loss of a sale of Bitcoin that took place on a different exchange (i.e. Gemini or Kraken). This nuance, among others, is principally what makes it difficult for the IRS to understand if crypto users are accurately reporting their taxable gains and losses each year.
This is where the intention of the new Form 1099-DA comes into play. Put simply, the IRS is now asking crypto exchanges to issue those tax forms to its users seemingly in hopes of tightening up reporting accuracy and aiding in future enforcement efforts. Of course, there are several issues with enacting this change, which is why the IRS also issued subsequent guidance in Revenue Procedure 2024-28.
The most important part of this revenue procedure put out by the IRS is the guidance around how taxpayers should handle the "transition" between universal allocation methodology to what it expects in 2025 onward, which is known as "depot separation" most commonly.
Under this new approach, the IRS is requiring that crypto gains and losses be calculated on a wallet-by-wallet basis.
Below is an example outlining the difference in this new approach.
Current Approach
Suppose that on 1/1/2025 a taxpayer purchases 1 Ether (ETH) for $2,000 in his Coinbase account.
In addition, that same taxpayer also purchases 1 Ether (ETH) for $1,000 in his Binance.us account on 3/1/2025.
The taxpayer then sells 1 ETH on 12/31/2025 for $8,000 in its Binance account.
Under the old approach, the taxpayer could calculate his gains as follows:
1 ETH sold on 12/31/2025 for $8,000 on Binance.us
Less:
1 ETH purchased on 1/1/2025 for $2,000 on Coinbase
= $8,000 - $2,000 = $6,000 in short-term capital gains
Remaining ETH cost basis in Binance.us = 0 ETH
Remaining ETH cost basis in Coinbase = 1 ETH x $1,000 = $1,000
However, while it is advantageous to use the cost basis of the ETH purchased on Coinbase for purposes of calculating a lower taxable gain, the taxpayer can no longer do so. Instead, it would look like this:
New Approach
1 ETH sold on 12/31/2025 for $8,000 on Binance.us
Less:
1 ETH purchased on 3/1/2025 for $1,000 on Binance.us
= $8,000 - $1,000 = $7,000 in short-term capital gains
Remaining ETH cost basis in Binance.us = 0 ETH
Remaining ETH cost basis in Coinbase = 1 ETH x $2,000 per ETH = $2,000
This is a simple example of a single asset held at two different exchanges but it gets increasingly more complex as assets and wallets or exchanges are added to the analysis. Further adding to the complexity, most taxpayers have (correctly so) been utilizing a universal allocation methodology before 2025. As such, there are likely several "tranches" of cost-basis amounts for a particular asset held across multiple wallets and exchanges. So complying with this new requirement creates the need for understanding how to handle the cutover or transition to this new approach. Accordingly, Revenue Procedure 2024-28 has established a "Safe Harbor" provision to guide taxpayers on how to handle this transition period. But first, not everyone can adopt this Safe Harbor approach. To do so, the taxpayer must meet certain requirements for eligibility defined within Section 4.02(4).
To be eligible for the safe harbor treatment, the following requirements must be met:
(1) Each remaining digital asset unit must be a capital asset in the hands of the
taxpayer. See section 1221.
(2) Each unit of unused basis must have been originally attached to a digital
asset unit that was a capital asset in the hands of a taxpayer.
(3) The digital asset unit from which the unused basis is derived and the
remaining digital asset units must be the same type of digital asset.
(4) The taxpayer must be able to identify and maintain records sufficient to show
the total number of remaining digital asset units in each of the wallets or
accounts held by the taxpayer.
(5) The taxpayer must be able to identify and maintain records sufficient to show
the number of units of unused basis, the original cost basis of each such unit
of unused basis, and the acquisition date of the digital asset unit to which the
unused basis was originally attached.
(6) A taxpayer must treat any allocation under this revenue procedure as
irrevocable for all purposes of section 1012.
If these conditions are met, the taxpayer can choose to make a "reasonable allocation" as of January 1st, 2025 of units of unused basis to a wallet or account that holds the same number of remaining digital asset units with respect to any type of digital asset for which the taxpayer is relying on this revenue procedure. In simpler terms, it means that the taxpayer can allocate the unused cost basis amounts for each asset across its remaining holdings to establish opening cost basis amounts for each asset held across multiple accounts or wallets. This effectively gives a clean opening cost basis amount for each asset on a per wallet or account basis beginning January 1st, 2025.
As mentioned previously, there are generally two ways that unused cost basis amounts can be allocated to a taxpayer's remaining asset holdings.
A taxpayer may make an allocation of specifically identified units of unused basis (specific unit allocation), by reference to characteristics that distinguish those units from other units of unused basis, to either a pool of remaining digital assets units within each wallet or account or, if the taxpayer is able to identify each remaining digital asset within each wallet or account, to the specific units of remaining digital assets within each wallet or account. A specific unit allocation is complete on the date that the taxpayer’s books and records first record the specific characteristics of the units of unused basis allocated to each pool of digital assets in the taxpayer’s wallets or accounts on a wallet-by-wallet or account-by-account basis, or, if the taxpayer is able to identify each remaining digital asset within each wallet or account, to the specific units of remaining digital assets within each wallet or account.
A taxpayer may, alternatively, make an allocation based on a rule prescribing the manner by which units of unused basis will be ordered and then allocated to a pool of remaining digital assets units within each wallet or account (global allocation). A global allocation must identify and order all units of unused basis by reference to characteristics that distinguish those units from all other units of unused basis and must allocate those ordered identified units to a pool of remaining digital asset units in each of the taxpayer’s wallets or accounts on a prescribed basis set forth in the rule.
For example, a global allocation might identify those units of unused basis that have the earliest or latest acquisition dates and, for each of those dates, the highest or lowest amounts of unused basis, and allocate such units successively to wallet A, wallet B, and wallet C. An allocation that permits the taxpayer to exercise discretion on or after January 1, 2025, with respect to how units of unused basis are allocated
to remaining digital asset units or to the taxpayer’s wallets or accounts is not a global allocation within the meaning of this revenue procedure. A global allocation is complete on the date that the taxpayer’s books and records first record the specific characteristics of the units of unused basis allocated to each pool of digital assets in the taxpayer’s wallets or accounts on a wallet-by-wallet or account-by-account basis.
The simplest way to think about the two available options taxpayers have under this safe harbor provision is that specific unit allocation requires you to identify every tranche of unused cost basis for each asset and individually allocate those actual unused cost basis tranches to the taxpayer's holdings immediately before January 1st of 2025. While there are some pros to this approach due to the flexibility it allows for, the requirements are stringent and complicated to execute.
Conversely, the global allocation methodology allows taxpayers to describe the "rules" or a framework of the methodology it intends to utilize for those remaining assets they hold as of the close of 2024.
Accordingly, in most cases, we're advising our clients to adopt a global allocation methodology.
For taxpayers who opt to utilize the specific allocation methodology, the following deadlines must be adhered to as described in Section 5.04:
A taxpayer making a specific unit allocation must satisfy the requirements set
forth in section 5.02(1) of this revenue procedure and complete the specific
unit allocations described in section 5.02(2)(a) of this revenue procedure
before the earlier of:
(a) The date and time of the first sale, disposition, or transfer by the taxpayer
of the same type of digital asset completed on or after January 1, 2025, or
(b) Either:
(i) The due date (including by extension) of the taxpayer’s Federal income
tax return or Form 1065, U.S. Return of Partnership Income, for the
taxable year that includes January 1, 2025 (the 2025 return); or
(ii) If the taxpayer is not otherwise required to file a 2025 return, the last
date for filing the 2025 return (without extensions) of the type of return
that would be applicable to the taxpayer if the taxpayer were required
to file a 2025 return.
Taxpayers who opt to utilize the global allocation methodology should take note of the following as described in Section 5.05:
(5) A taxpayer making a global allocation described in section 5.02(2)(b) of this
revenue procedure:
(a) Must describe the global allocation method in the taxpayer’s books and
records before January 1, 2025;
(b) Must satisfy the requirements set forth in sections 5.02(1) of this revenue
procedure and complete the allocations of all units of unused basis to the
pools of remaining digital asset units within each of the taxpayer’s wallets
or accounts before the later of the dates set forth in section 5.02(4)(a) and
(b) of this revenue procedure, as applicable; and
(c) Must comply with the following rules with respect to sales, dispositions or
transfers of any remaining digital assets units on or after January 1, 2025. If such sale, disposition or transfer occurs after the taxpayer has completed the global allocation, the taxpayer is permitted to identify the units sold, disposed of, or transferred under § 1.1012-1(j)(2) of the 2024 final regulations (specific identification of digital asset units held in an unhosted wallet) or § 1.1012-1(j)(3)(ii) of the 2024 final regulations (adequate identification of units held in the custody of a broker). If such sale, disposition or transfer occurs before the taxpayer has completed the global allocation, the taxpayer may make a specific identification (or adequate identification) of any remaining digital asset units that are sold, disposed of, or transferred only by using a standing order or instruction communicated to the taxpayer’s broker or a standing instruction recorded in the taxpayer’s books and records. This standing order must be applied to select any remaining digital asset units sold, disposed of, or transferred after the global allocation is complete. Any other type of specific identification by the taxpayer will not be treated as sufficient to identify any remaining digital asset units sold, disposed of, or transferred under §1.1012-1(j)(2) of the 2024 final regulations (specific identification of digital asset units held in an unhosted wallet) or § 1.1012-1(j)(3)(ii) of the 2024 final regulations (adequate identification of units held in the custody of a broker) before the date that the taxpayer has completed the allocation of units of unused basis to the pools of remaining digital asset units within each of the taxpayer’s wallets or accounts.
A few other key points to be aware of are below:
1. A taxpayer cannot choose to use cost-basis amounts that were previously identified (and used) in the calculation of taxable gain or loss amounts in a tax year before the 2024 tax year.
2. A taxpayer who does not adopt a reasonable allocation methodology before January 1st of 2025, as defined by Section 5.02, and/or fails to meet the requirements outlined in Section 4.02 of the revenue procedure may face an assessment of additional tax, penalties, and interest.
3. If adopting a global allocation methodology, the taxpayer cannot change the methodology described after the adoption of their plan under the Safe Harbor rules. In other words, you can't choose one method for 2024 and another method for the 2025 tax year. You have to stay consistent in your approach.
For those opting to utilize a global allocation methodology, the steps that should be taken before January 1st 2025 are relatively straightforward. To help, we've put together template resources to help you navigate this change. Those necessary steps are as follows:
1. Identify and take a snapshot of all of your digital asset (crypto) holdings immediately before January 1st 2025 for all accounts and wallets as described in Section 4.02(4) below:
"The taxpayer must be able to identify and maintain records sufficient to show the total number of remaining digital asset units in each of the wallets or accounts held by the taxpayer."
Please use our template document and the included instructions found [HERE] to perform this step.
Note: It's not clear from existing guidance exactly what it is the IRS is looking for to establish your year-end holdings. Our recommendation is to be overly conservative and take a screenshot of every account and asset balance (with timestamp included) and save this in your records. This documentation is not something that is filed with your tax return. However, it may be necessary to produce this information if you are ever subject to an IRS audit.
2. Select a global allocation methodology and describe the methodology in detail in your plan adoption document
An example plan adoption document can be found [HERE] for this step.
Note: The global allocation methodology we suggest is generally consistent with the "First in First Out" (commonly known as "FIFO") approach, with one additional wrinkle. The subtle difference is that we recommend first allocating your unused cost basis tranches (starting from the earliest acquisition date to the most recent) to your self-custodied wallets (i.e. a Ledger or Metamask wallet) followed by wallets custodied by a third party (i.e. exchanges). The rationale behind this is that you'll generally want to associate your earliest purchases (which will usually be at a lower cost basis) to the wallets where you're more likely to hold the asset rather than exchange hosted wallets where you're more likely to sell in the near term. However, there is some flexibility in adopting this element of the plan, so please speak with our team to discuss what method is most appropriate for you.
3. Sign your plan adoption document and retain it in your records before January 1st 2025.
Before year-end, do the following:
1. Record and document all crypto asset holdings as of midnight December 31st, 2024.
2. Adopt and sign a reasonable allocation methodology for satisfying the Safe Harbor procedures outlined in Rev. Proc. 2024-28.
There are ways to simplify this process by avoiding it altogether. Those options are:
1. Selling all assets you currently own before year-end or;
2. Consolidating all assets owned to a single wallet or exchange before year-end
However, for many crypto investors, this may be suboptimal from a taxation standpoint. If so, work with us to make sure you're properly set up for 2025 and beyond by implementing the transitionary steps needed for crypto tax compliance in 2025 and beyond.