Advice for Practitioners: Simplifying the IRS’s Latest Guidance on Digital Asset Reporting
The IRS has introduced significant updates on digital asset reporting, giving taxpayers an opportunity to manage unused basis before new rules take effect in 2025. These changes, outlined in recent guidance, include a safe harbor allowing unused basis to be reallocated across wallets or accounts. Practitioners advising clients on digital asset transactions should act now to ensure compliance and reduce administrative burden.
What Is the Digital Asset Basis Safe Harbor?
Starting January 1, 2025, the IRS will require taxpayers to shift from the universal method of accounting for digital assets to a wallet-by-wallet or account-by-account method. This change addresses challenges with tracking cost basis across multiple wallets and accounts.
Rev. Proc. 2024-28 provides a safe harbor, allowing taxpayers to allocate unused basis of digital assets within their accounts before the new rules come into effect. This transition offers a way to prepare for compliance while reducing potential errors in future reporting.
What Should Tax Practitioners Know?
1. Key Deadlines:
- By January 1, 2025, taxpayers must adopt the new wallet-by-wallet method.
- Allocations under the safe harbor must be completed by this date or by the tax return due date for the taxable year that includes January 1, 2025.
2. Allocation Methods:
The IRS provides two methods for reallocating unused basis:
- Global Allocation Method:
This simplifies the process by consolidating unused basis into as few wallets or accounts as possible. For example, a taxpayer with digital assets across five wallets could move all unused basis into a single account. This reduces complexity for future calculations and aligns with the new reporting requirements. - Specific Allocation Method:
This option allows taxpayers to strategically allocate unused basis to specific wallets or assets. While more flexible, it requires precise documentation and careful timing.
Why Practitioners Should Act Now
Reducing Administrative Burden: The global allocation method offers a streamlined way to prepare for the new rules. By consolidating unused basis, taxpayers can simplify compliance and avoid last-minute calculations.
IRS Enforcement: With increased scrutiny of digital asset transactions, prioritizing compliance is essential. The IRS’s Criminal Investigation Unit is actively pursuing cases involving digital assets. Proper use of the safe harbor can help taxpayers avoid penalties.
Documentation Matters: Practitioners should advise clients to maintain clear records of their allocations, including the method chosen and the timing of transactions. This ensures protection under the safe harbor and minimizes the risk of audits.
Practical Example
Imagine a taxpayer holds digital assets across five wallets and uses software that applies the first-in, first-out (FIFO) accounting method. Under the old rules, this software might pull cost basis from Wallet 3 for a transaction in Wallet 1. The new rules require precise tracking by wallet, making the universal method obsolete.
By reallocating all unused basis into a single wallet using the global allocation method, the taxpayer simplifies compliance and reduces administrative effort for 2025 reporting.
Final Thoughts
The IRS’s updates on digital asset reporting reflect the complexity of this evolving field. Practitioners must stay informed and proactive to guide their clients through the transition. By leveraging the safe harbor and planning ahead, taxpayers can meet compliance requirements while minimizing complications.
Pro Tip: Use this opportunity to educate clients about the importance of tracking and documenting digital asset transactions.
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