16 November 20223 minute read

Form 1040 instructions provide guidance on digital asset transactions for the 2022 tax season

On October 17, the IRS released new draft instructions for the 2022 Form 1040 that provide some limited guidance on reporting digital asset transactions and a newly expanded definition of “digital assets" for this purpose. Since the new reporting question was released back in September, taxpayers have been anticipating what further guidance may be contained in the 2022 Form 1040 instructions, given the expanded scope of the question.

The draft instructions provide some confirmation that the broad term “digital assets" has been incorporated into the existing "virtual currency" language. In particular, "digital assets" is defined as "…any digital representations of value that are recorded on a cryptographically secured distributed ledger or any similar technology. For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins. If a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes."

This expanded definition specifically includes non-fungible tokens (NFTs), which seems to confirm that the IRS may view the asset more like cryptocurrency and less like collectables or traditional art. Further, the last sentence in the definition may also encompass many digital assets that were not previously thought of as reportable, such as “play-to-earn" game tokens where players play games to receive tokens to use as in-game currency.

In terms of when to check “yes" to the Form 1040 question, the draft instructions provide a laundry list of broad transactions that would necessitate reporting, including where a taxpayer:

  • Received digital assets as payment for property or services provided
  • Received digital assets as a result of a reward or award
  • Received new digital assets as a result of mining, staking, and similar activities
  • Received digital assets as a result of a hard fork
  • Disposed of digital assets in exchange for property or services
  • Disposed of a digital asset in exchange or trade for another digital asset
  • Sold a digital asset
  • Transferred digital assets for free (without receiving any consideration) as a bona fide gift or
  • Otherwise disposed of any other financial interest in a digital asset.

The draft instructions further explain, however, that there are certain instances where a taxpayer could have an otherwise relevant transaction and not check "yes," including simply holding a digital asset in a wallet, transferring assets between personally held wallets, and purchasing digital assets.

Lastly, the instructions also note that the tax treatment of digital asset transactions is generally capital (reported on Form 8949), although if received as wages or in exchange for services, digital assets constitute compensation.

While the updated instructions provide more clarity and context than prior years, the new draft instructions still do not provide satisfying guidance on tax reporting overall for digital assets and may continue to demand overreporting in an industry where even basic information reporting can be challenging due to the nature of the assets.