Understanding Rev. Proc. 2024-28: Wallet-Based Tracking for Digital Asset Taxation

1. Introduction

Rev. Proc. 2024-28, recently issued by the Internal Revenue Service (IRS), introduces significant changes to the taxation of digital assets. Effective January 1, 2025, this procedure mandates that taxpayers implement wallet or account based tax lot tracking, rather than using a universal accounting method. This revenue procedure aims to ensure accurate basis tracking for crypto assets and emphasizes the importance of crypto reconciliation for compliance.

2. The End of Universal Wallet Accounting

The universal method assumed all digital assets were held in a single wallet or account, even while segregated across multiple wallets or accounts. This method allowed taxpayers to specifically identify the basis for the cryptocurrency sold from the pool of crypto assets. However, Rev. Proc. 2024-28 eliminates this method, now requiring a per wallet or per account approach.

With this new requirement, greater precision can be achieved, but some ambiguities remain. What exactly is considered a “wallet” is still up to interpretation since the IRS has yet to define it. Similarly, there is no clear guidance on how extended public key (xpub) addresses and subaccounts on centralized exchanges (CEXs) will be treated under these rules. Accurate crypto reconciliation becomes critical to addressing these ambiguities and maintaining compliance.

3. Safe Harbor and Transition Relief

To ease the transition, Rev. Proc. 2024-28 provides a safe harbor for taxpayers who previously used the universal method. Under this, unused basis can be reallocated across existing crypto asset holdings as of January 1, 2025. This aims to align taxpayers’ Form 8949 (Sales and Other Dispositions of Capital Assets) and brokers’ Forms 1099-DA (Digital Asset Proceeds from Broker Transactions), to prepare brokers for reporting basis on transactions in 2026.

This Safe Harbor is a once in a lifetime opportunity for taxpayers to optimize their tax position. The reallocation of cost basis must be completed by the earliest of the first disposition after January 1, 2025 or the due date of the 2025 federal income tax return. It’s also crucial to note that only capital assets, and not ordinary assets, held as of January 1, 2025 are eligible.

4. Practical Impact on Traders

Experienced traders may find it challenging to comply with the wallet by wallet approach. Accurate record keeping and basis tracking for each digital asset across different wallets can be time-consuming. Specialized tax software may be needed because of the increased complexity.

Additionally, contemporaneous specific identification (Spec ID) is now required. The specific tax lot of a digital asset being sold needs to be designated by the taxpayers before the transaction settles. With blockchain transactions often settling in seconds, this is a challenge for crypto traders. Predefined standing orders, like HIFO, can help traders navigate these new requirements.

By making a reasonable allocation of units of unused basis to a wallet or account through the safe harbor provision, traders can ensure that their records accurately reflect the basis of their crypto assets, potentially reducing taxes. Through this, mismatches can be avoided in reporting income tax, improving compliance with the IRS regulations. Implementing a proper crypto reconciliation process can further simplify this complex task.

5. Effects on Capital Gains under Crypto Cost Basis Methods

Tracking and reporting the basis of taxpayers’ digital assets is significantly changed by Rev. Proc. 2024-28. The universal wallet method is eliminated , requiring different cost basis methods (FIFO, Specific Identification, HIFO, WAC, and LIFO) to be applied on a per wallet or per account basis. Examples using Bitcoin (BTC) are explored below to see the impact on short-term and long-term capital gains.

1. First In, First Out (FIFO)

Scenario:

• Wallet A - 2 BTC (1 BTC at $20,000 bought in January 2023, 1 BTC at $25,000 bought in March 2023).
• Wallet B - 2 BTC (1 BTC at $40,000 bought in February 2024, 1 BTC at $70,000 bought in March 2024).
• Sale - 1 BTC sold in January 2025 for $100,000.

Before Rev. Proc. 2024-28 (Universal Wallet Tracking):

• Method - FIFO across wallets lets you sell the January 2023 BTC from Wallet A.
• Result - $80,000 long-term gain (held over one year).
• Tax Impact - Lower tax rate due to long-term holding is favorable.

After Rev. Proc. 2024-28 (Wallet-Based Tracking):

• Method - FIFO applies only within each wallet.
• Result - Selling the January 2023 BTC from Wallet A still gives an $80,000 long-term gain. Selling the February 2024 BTC from Wallet B results in a $60,000 short-term gain.
• Tax Impact - Higher tax rate due to short-term holding if Wallet B is used, due to wallet-based tracking.

2. Specific Identification (Spec ID)

Scenario: Same BTC holdings and sale price.

Before Rev. Proc. 2024-28 (Universal Wallet Tracking):

• Method - Specific Identification lets you choose the high-basis BTC from Wallet B (March 2024 at $70,000).
• Result - $30,000 short-term gain (held less than a year).
• Tax Impact - Higher tax rate due to short-term holding, but gain amount is minimized.

After Rev. Proc. 2024-28 (Wallet-Based Tracking):

• Method - Specific Identification is limited to individual wallets.
• Result - Selling the March 2024 BTC from Wallet B still gives an $30,000 short-term gain. Selling the March 2023 BTC from Wallet A results in a $75,000 long-term gain.
• Tax Impact - Taxes may increase if you cannot select across wallets due to wallet-based tracking.

3. Highest In, First Out (HIFO)

Scenario: Same BTC holdings and sale price.

Before Rev. Proc. 2024-28 (Universal Wallet Tracking):

• Method - HIFO across all holdings lets you sell the highest-cost BTC (Wallet B’s March 2024 BTC at $70,000).
• Result - $30,000 short-term gain (held less than a year).
• Tax Impact - Higher tax rate due to short-term holding, but gain amount is minimized.

After Rev. Proc. 2024-28 (Wallet-Based Tracking):

• Method - HIFO applies separately within each wallet.
• Result - Selling the March 2024 BTC from Wallet B still gives an $30,000 short-term gain. Selling the March 2023 BTC from Wallet A results in a $75,000 long-term gain.
• Tax Impact - Taxes may increase if you cannot apply HIFO across wallets due to wallet-based tracking.

4. Weighted Average Cost (WAC)

Scenario: Same BTC holdings and sale price.

Before Rev. Proc. 2024-28 (Universal Wallet Tracking):

• Method - Average BTC cost using WAC across wallets is $38,750 ($20,000 + $25,000 + $40,000 + $70,000) / 4.
• Result - $61,250 gain ($100,000 - $38,750), with the specific BTC sold determining the holding period.
• Tax Impact - Balanced gains due to blended cost basis.

After Rev. Proc. 2024-28 (Wallet-Based Tracking):

• Method - WAC is applied individually for each wallet.
• Result - Selling BTC from Wallet A has an average cost of $22,500, yielding a $77,500 long-term gain. Selling BTC from Wallet B has an average cost of $55,000, yielding a $45,000 short-term gain.
• Tax Impact - Complicated tax planning due to applying WAC on a per wallet basis.

5. Last In, First Out (LIFO)

Scenario: Same BTC holdings and sale price.

Before Rev. Proc. 2024-28 (Universal Wallet Tracking):

• Method - LIFO across all wallets allows selling the most recent BTC, Wallet B’s March 2024 BTC at $70,000.
• Result - $30,000 short-term gain (held less than a year).
• Tax Impact - Higher tax rate due to short-term holding, but LIFO minimizes gain amount in a bull market.

After Rev. Proc. 2024-28 (Wallet-Based Tracking):

• Method - LIFO is restricted to each wallet’s individual holdings.
• Result - Selling the March 2024 BTC from Wallet B still gives an $30,000 short-term gain. Selling the March 2023 BTC from Wallet A results in a $75,000 long-term gain.
• Tax Impact - Taxes may increase if LIFO is applied in a wallet with short-term gains.

Rev. Proc. 2024-28’s wallet-based tracking restricts the ability to optimize taxes across all holdings. This flexibility of common methods like FIFO, Specific Identification, HIFO, WAC, and LIFO is affected by this approach. Managing short-term and long-term capital gains efficiently will require careful reallocation of cost basis across wallets before the snapshot on January 1, 2025. While moving all crypto into one wallet might simplify compliance with safe harbor provisions, it is not practical for maintaining good crypto wallet hygiene and security.

6. Implications for Bitcoin Wallet Addresses and Blockchain Protocols

The transition to wallet based tracking by Rev. Proc. 2024-28 will have a big impact on record keeping for different blockchain protocols. Discussed below are the effects based on the UTXO and account-based models.

Unspent Transaction Output (UTXO) Model

These blockchains are hit hard by the new IRS guidelines. The Unspent Transaction (UTXO) protocol generates a new address for every transaction. The primary benefit of blockchains using this, such as Bitcoin, Bitcoin Cash (BCH), and Litecoin (LTC) is increased privacy.

Bitcoin users mostly rely on Hierarchical Deterministic (HD) wallets utilizing xpub to manage the multiple addresses within an UTXO wallet. All addresses linked to the wallet can be viewed using the xpub, simplifying compliance for tax reporting. However, the IRS guidelines may not allow this pooled tracking method anymore, as each address derived from an xpub might now need separate tracking. Further IRS clarifications are needed to determine if xpub addresses can be treated collectively, but currently single address tracking may be required.

Account-Based Model

On the other hand, account-based model blockchains like Ethereum (ETH) and Solana (SOL) will find it easier to comply with the new IRS guidelines. This structure uses a single address to manage transactions, making cost basis tracking much simpler and eliminating the need for multiple address management seen in UTXO systems.

7. Key Insights for Different Crypto Users

Airdrop Farmers

Those who farm airdrops normally have multiple wallets, some even in the hundreds, and these wallets are carefully segregated to avoid being marked as sybil. Specialized software may be needed to track the basis of these digital assets, especially since some airdrops require claiming.

Shitcoin Traders

With the rise of Pump.fun, shitcoin trading is at an all time high. Accurate record keeping of each transaction’s basis would be crucial since it is normal to allocate buys across multiple wallets to avoid wallet tracking.

Web3 Employees

Employees paid in cryptocurrencies must track the basis of each payment in the wallet it is received, ensuring proper reporting of income and subsequent gains or losses.

NFT or Ordinals Collectors

Since Non-fungible tokens (NFTs) and Bitcoin Ordinals have unique identifiers, it is relatively simple to track the cost basis of these digital assets in the wallet where it is held.

Miners and Stakers

Those who receive awards through staking and mining need to accurately track the cost basis of the awards in their respective wallets when received.

Yield Farmers

Yield farmers, who frequently move digital assets between different protocols to maximize returns, must track the basis for each transaction in the specific wallet it was conducted. Keeping track of this would be complex but necessary for tax compliance.

Leverage Traders

Gone are the days where futures trading was only available on centralized exchanges (CEX), decentralized exchanges (DEX) now offer this. Currently, these are under heavy legal scrutiny. However, for tax compliance it would still need to be tracked on a per wallet basis.

8. Actions for Businesses

Start Wallet-Based Tracking Practices

Ensure that each digital asset’s basis is recorded in its respective wallet by the snapshot date, January 1, 2025. Start tracking tax lots at the wallet or account level. Complying with this new IRS regulation, may require a change in your accounting practices.

Reallocate Unused Tax Basis

Rev. Proc. 2024-28 ’s safe harbor provision allows taxpayers to irrevocably reallocate unused basis in crypto assets among wallets or accounts by January 1, 2025, provided it meets the requirements. Detailed record keeping and strategic reallocation ensure accurate basis tracking and potential to save taxes.

Consult with Experts

Need help navigating the new digital asset tax regulations? We stand as your vigilant financial co-pilot, ensuring compliance and peace of mind. Book a free consultation today at Onchain Accounting and stay ahead in the crypto landscape!

Disclaimer: No financial, tax, legal advice or opinion is given through this post. All information provided is for educational purposes only and may not apply to your specific situation.