What You Need to Know About Rev. Proc. 2024-28
Aug 22, 2024Building on our previous blog post about final IRS broker regs, here's what else you should know if you're a digital asset holder.
The IRS states:
“Section 1.1012-1(h) and (j) of the 2024 final regulations will apply to all acquisitions and dispositions of digital assets on or after January 1, 2025.”
Section 1012 relates to cost basis reporting.
One good thing about Rev. Proc. 2024-28
The IRS listened to one of the most important comments about the negative impact of the regs on taxpayer cost basis tracking. This relates to the many “hands in the pie” conundrum I’ve been talking about. Centralized exchanges like Coinbase could report cost basis different from taxpayer’s basis and create reporting mismatches into perpetuity. In addition, the limitations of crypto tax software (as it stands right now) could make it nearly impossible for taxpayers to resolve discrepancies and figure out where the mismatches are.
The IRS acknowledged:
“The comments expressed the view that transitioning from the universal or multi-wallet approach to the single wallet or account-based rules in the 2023 proposed regulations, if adopted in the final regulations, could lead to ongoing discrepancies between a taxpayer’s basis records and the basis reported to the taxpayer by brokers on Forms 1099-DA, Digital Asset Proceeds From Broker Transactions, and that these discrepancies could be further exacerbated by the limitations of current basis-tracking software.”
The acknowledgement translates into marginal “relief” for taxpayers. The real relief would be scratching 100% of all cost basis reporting and/or scratching the broker reporting regs altogether. Neither of those is going to happen.
New safe harbor benefit from Rev. Proc. 2024-28
The IRS provides safe harbors from time to time especially amidst new regulations that create transition challenges for taxpayers. The safe harbor allows taxpayers to a free pass from penalties, interest, and assessments if the taxpayers follow safe harbor rules.
The marginal “relief” in Rev. Proc. 2024-28 is a new safe harbor which says:
“The taxpayer may make any reasonable allocation as of January 1, 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...”
The reasonable allocation provides some discretion for taxpayers, but the allocation exercise is the new nightmare for crypto taxpayers.
How do I get into the safe harbor?
The IRS is not clear about how taxpayers can prove they took the steps needed to be in the safe harbor. Generally speaking, the allocation needs to take place before January 1, 2025 (although there is more timeline discretion). The taxpayer could retroactively do an allocation after January 1, 2025 and say it was done beforehand. More to come later because this part is very complicated.
Two distinct exercises for digital asset users
One-time cost-basis allocation for digital assets
The allocation exercise is a one-time thing created by Rev. Proc. 2024-28 and it does not give taxpayers enough time to understand the task at hand and make the allocation by December 31, 2024. Transferring and consolidating digital assets strategically among wallets may be a recipe to alleviate some of the allocation headache.
Key Takeaway
The allocation segues your cost basis within and among your wallets and accounts so that all subsequent transactions after January 1, 2025 are in compliance with the overall final regulations.
Choose FIFO or specific identification
After the allocation is done, taxpayers can choose either FIFO (first in first out) cost basis method, the “default method” or Spec ID (specific identification). This should make sense because we’ve been talking about this for a while and these two methods already applied before January 1, 2025 and will still apply after December 31, 2024.
- FIFO: Requires no work by the taxpayers when selling digital assets. The oldest digital assets are always “sold” first so brokers and tax software should have no issues here. The tradeoff is taxpayers have no ability to control gains and losses.
- Spec ID: Gives taxpayers the ability to choose what gains and losses to trigger and when. This can make a big difference in your tax bill and is more desirable at first glance. The tradeoff is taxpayers must identify the tranche, tax lot, or batch of crypto they want to sell before they sell it.
- Crypto tax software: Does not provide the ability to pre-identify the cost basis of the trade you want to make (although a few are working on it). Centralized exchanges (digital asset brokers) have the same problem because they do not provide a way for taxpayers to instruct the broker about which lot to sell. However, the chatter is the exchanges are working on such a feature.
Nonetheless, this is more easily solved on the centralized exchange side rather than the self-custody self-identification part of the equation.
Key Takeaway
The IRS does not view a shift from FIFO to Spec ID and vice versa as a change in accounting method (a complicated transition exercise). Therefore, taxpayers may have a rare opportunity to perform the one-time allocation and then change to or from FIFO and Spec ID for all transactions after January 1, 2025. Nobody is talking about this wildcard right now so be thinking about it.