New Guidance on Digital Asset Basis Allocation for 2025

The Internal Revenue Service (IRS) has released critical guidance in Revenue Procedure 2024-28 to help taxpayers allocate the unused basis of digital assets across wallets and accounts. This guidance, effective January 1, 2025, introduces a safe harbor that facilitates the transition to stricter basis tracking requirements.

Why the guidance matters:

Before the final regulations were established, the IRS allowed taxpayers to use the universal method for tracking the basis in digital assets. This method assumes all the taxpayer’s digital assets are held in a single wallet or account, even when they are spread across multiple wallets or accounts. When a digital asset was sold, the account holder could identify the basis of the specific asset sold from the pool of assets. However, starting in 2025, taxpayers must apply wallet-by-wallet basis tracking as mandated by new IRS regulations. 

What is the Safe Harbor approach?

The safe harbor allows taxpayers to allocate unused basis from their digital asset holdings as of January 1, 2025, across wallets or accounts. This ensures taxpayers don’t lose track of their cost basis while adapting to the updated rules. Unused basis refers to the remaining, unallocated original cost of digital assets that haven’t been used to determine gains or losses in prior transactions.

Eligibility:

To qualify for the safe harbor, taxpayers must: 

1. Hold digital assets acquired before January 1, 2025.
   
   
2. Have remaining digital asset units and unused basis in those assets as of January 1, 2025.
   
   
3. Maintain sufficient records to substantiate the number of digital assets, their original cost, and acquisition dates. 

If the amount or availability of basis is being contested in a U.S. court, the IRS Independent Office of Appeals, or an IRS examination before January 1, 2025, the safe harbor doesn’t apply unless the dispute is resolved before the allocation deadline.

How to allocate basis under the Safe Harbor approach: 

The guidance offers two methods for basis allocation: 

1. Specific Unit Allocation: A taxpayer can allocate unused basis to specific units of digital assets by identifying distinguishing characteristics. This allocation can be made to a pool of remaining digital assets in each wallet or account, or to individual assets if each one can be identified. The taxpayer must maintain detailed record-keeping, including acquisition dates and costs for individual units.
   
   
2. Global Allocation: Taxpayers can apply a predefined rule (e.g., highest basis units first or FIFO) to allocate unused basis across wallets or accounts. The rule must be documented in the taxpayer’s records by January 1, 2025.

What can taxpayers do? 

Taxpayers and tax practitioners need to act promptly on the transition relief outlined in Rev. Proc. 2024-28, as the safe-harbor deadline is fast approaching. To simplify the administrative burden ahead of the Jan. 1, 2025, deadline, taxpayers can take one or more following action: 

1. Move all digital assets into one account by Dec. 31, 2024, to simplify allocation of unused basis, though the concentration risk should be considered. 
   
   
2. Sell all digital assets held by a custodian before Jan. 1, 2025, to eliminate the need for basis allocation, though this may trigger realized gains or losses, and repurchasing assets later may require accurate record-keeping.
   
   
3. Alternatively, leave holdings as they are and allocate unused basis according to Rev. Proc. 2024-28 to meet the safe-harbor requirements. These actions are not investment advice but can reduce the administrative burden associated with the safe harbor. 

Steps to comply with the guidance:

• Take Stock of Your Digital Assets: As of January 1, 2025, identify all digital assets you hold in each wallet or account. 

• Choose an Allocation Method: Decide whether to use specific unit allocation or global allocation, and document your approach. 

• Maintain Comprehensive Records: Taxpayers are advised to maintain comprehensive records related to their digital assets. This includes transaction history, dates, purchase amounts, and associated costs. The IRS emphasizes the need for organized documentation to facilitate accurate tax reporting and to mitigate the risk of audits. 

• Meet Deadlines: Complete allocations before your first digital asset transaction in 2025 or the filing deadline for your 2025 tax return (including extensions). 

Failing to meet the safe harbor’s requirements may disqualify taxpayers, exposing them to potential penalties, additional taxes, and interest. 

Key challenges that taxpayers can face:

1. Cost Basis Reporting by Exchanges: When digital assets are sent to Exchanges without clear origin records, the exchange flags the cost basis as $0. This results in overstated gains when assets are sold. Such discrepancies mean that 1099-DA reports to the IRS will not align with an investor’s Form 8949, leading to potential scrutiny or errors.
   
   
2. Impact on Software Users: Software often use universal calculation methods rather than account-specific tracking. The IRS’s requirement for wallet-by-wallet basis tracking means investors may need to transition from software solutions to manual calculations for each account or exchange.
   
   
3. Ensuring Accurate Historical Basis Tracking: Investors face challenges in verifying whether their software has accurately tracked cost basis or avoided duplicating basis across wallets. Once the safe harbor option is chosen, the cost basis for all token holdings is effectively pooled, leaving no detailed record of which inventory pool (specific or global) was used in the past. This lack of transparency complicates future audits or calculations.

How to address current challenges: 

• Transitioning from Universal Software Calculations: Investors using software must evaluate whether the software complies with wallet-by-wallet tracking requirements. If not, they may need to transition to manual tracking or ensure the software allows per-wallet basis reporting for future calculations. 

• Avoiding Cost Basis Duplication: Investors should audit their historical transactions to ensure that basis hasn’t been duplicated across wallets. Use the safe harbor to create a clean break starting January 1, 2025, while retaining documentation of past basis allocation methods for potential IRS inquiries.