From the Tax Law Offices of David W. Klasing - New IRS Guidance on Cryptocurrency Complicates Reporting but Includes Temporary Safe Harbor

IRVINE, Calif., Feb. 10, 2025 /PRNewswire/ -- Cryptocurrency has found popularity among Americans as both an investment vehicle and a method of engaging in transactions with others. With its increase in popularity, the Internal Revenue Service (IRS) has introduced some complicated reporting requirements to ensure compliance with U.S. tax laws. Recently released Revenue Procedure 2024-28 and Notice 2025-7 has further clarified the obligations of cryptocurrency owners. This blog post explores these reporting requirements and how cryptocurrencies are taxed in the U.S. If you have questions relating to the reporting or overall taxation of your cryptocurrency portfolio or transactions, it is in your best interest to contact an experienced cryptocurrency tax attorney.

Overview of U.S. Taxation of Cryptocurrency

Cryptocurrencies, commonly referenced as digital assets in tax regulations, are treated as property for U.S. tax purposes (IRS Notice 2014-21). This treatment means that general tax principles that typically apply to property transactions also apply to cryptocurrency transactions. Those general rules include:

1. Capital Gains and Losses:
   • When you sell or exchange cryptocurrency, you must calculate the capital gain or loss.
   • This requires determining the asset's basis, holding period (to determine short- or long-term status), and fair market value at the time of the transaction.
2. Ordinary Income:
   • Cryptocurrency received as payment for goods or services is treated as ordinary income. Where services are provided self-employment tax will also be owed.
3. Mining and Staking Rewards:
   • Income from mining or staking is taxable as ordinary income subject to self-employment taxes when received and must be reported to the IRS.
4. Airdrops and Forks:
   • Airdrops and hard forks typically generate ordinary income, which must be reported in the calendar year of receipt even if the taxpayer does not sell or transfer the cryptocurrency.

How Cryptocurrency Transactions are Reported

When a taxpayer sells or exchanges digital assets, they must report the transaction to the IRS as part of their annual tax return. The process involves a couple of different forms and reporting steps, with the recent guidance from the IRS shaping how taxpayers track and document their ownership and transactions

1. Initial Reporting on Form 1040:
   • Taxpayers must answer "Yes" or "No" to the cryptocurrency question on Form 1040, indicating whether they engaged in any cryptocurrency transactions during that specific tax year. This is a broad question that covers all types of cryptocurrency activities.
2. Detailing Transactions on Form 8949:
   • Cryptocurrency transactions are reported on Form 8949 (the form that all transactions involving capital assets are reported), where taxpayers categorize each transaction as either short-term or long-term based on the holding period. The form requires specific details like the date the asset was acquired, its basis, its date of disposition, and the amount received in exchange for it.
3. Reconciling with Form 1099-DA:
   • Starting on January 1, 2025, brokers will be required to provide a Form 1099-DA for digital asset transactions. This form will report proceeds from cryptocurrency sales.
4. Accounting for Basis:
   • Determining the basis of cryptocurrency is important for true and accurate tax reporting. This is where recently released Revenue Procedure 2024-28 and Notice 2025-7 come into play, providing guidance for basis determination and reporting transitions.

The Impact of Revenue Procedure 2024-28 and Notice 2025-7

Revenue Procedure 2024-28

Rev. Proc. 2024-28 sets forth a framework for taxpayers to transition from prior basis determination methods (e.g., multi-wallet or universal basis tracking) to an account-by-account or wallet-by-wallet basis. This guidance applies to transactions occurring on or after January 1, 2025. This change certainly makes tracking digital asset attributes more complicated.

Impact on Reporting:

• Basis Allocation:
  • Taxpayers must allocate the basis of their crypto held in various wallets or accounts. This is critical for determining the amount of gain recognized upon disposition.
  • The procedure allows for either specific identification of units sold or the use of the FIFO (first-in, first-out) method, provided adequate records are maintained.
• Recordkeeping Requirements:
  • Importantly, taxpayers must maintain detailed records to prove the basis of digital assets. The information that must be tracked includes the acquisition date, cost, and the fair market value at the time of transaction.
• Form 8949 Preparation:
  • The shift to account-specific basis determination is an attempt to ensure consistency between taxpayer records and broker-reported amounts on Form 1099-DA.

Notice 2025-7

To address the limitations inherent in record-keeping technologies among brokers, Notice 2025-7 provides temporary relief for taxpayers during the 2025 tax year. This notice allows taxpayers to rely on their own records to make proper identification of cryptocurrency units sold or transferred if brokers cannot facilitate account-specific tracking. Though, it is important to remember that this only applies for 2025.

Impact on Reporting:

• Temporary Relief Period:
  • From January 1, 2025, to December 31, 2025, taxpayers can use alternative identification methods if brokers are not yet able to provide detailed basis tracking.
• Fallback to FIFO Rule:
  • If taxpayers fail to properly identify units, the default FIFO rule takes over, which assumes the earliest acquired units are sold first.
• Interaction with Revenue Procedure 2024-28:
  • Taxpayers using the safe harbor in Rev. Proc. 2024-28 can also rely on the temporary relief provided in this notice, ensuring a transition to the new framework.

Practical Steps for Taxpayers

To comply with the requirements that we summarized above and ensure accurate income tax reporting, taxpayers should focus on maintaining detailed records of all of their cryptocurrency transactions. This involves tracking acquisition dates, costs, fair market values, and transaction details for all cryptocurrency within a taxpayer's portfolio. Consulting with a dual licensed Tax Attorney & CPA familiar with cryptocurrency taxation and reporting is essential for navigating complex transactions and regulations that continue to evolve.

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