INSIGHT

Crypto tax funds, tokenized real estate & DeFi brokers and lending platforms

Javier Salinas, Michelle Choy • February 28, 2025

Industries: Blockchain & Digital Assets

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As the digital asset landscape continues to evolve at a breakneck pace, the need for authoritative insights and forward-thinking perspectives has never been more critical. The crypto industry demands a deep understanding of blockchain technology, as well as the ability to anticipate the implications of regulatory shifts, market dynamics and technological advancements. Staying ahead of trends is essential for shaping the conversation, influencing best practices and fostering a deeper understanding of how decentralized technologies can redefine global finance, commerce and beyond. 

The interplay between innovation and regulation is becoming increasingly intricate across crypto funds, tokenized real estate, DeFi brokers, and lending platforms. Understanding the tax implications of digital assets, the evolving legal framework and the opportunities these technologies present is paramount for investors, fund managers and policymakers alike. 

This piece delves into key areas such as:  

• The applicability of certain tax rules to crypto funds 
• The tax treatment considerations of tokenized real estate 
• The regulatory environment surrounding DeFi platforms 

Throughout the article, you’ll discover insights into how these developments are shaping the future of the digital economy. 

Crypto funds – Investor, trader and dealer status 

Crypto funds operating in the asset management and investment space are likely to get more clarity on the following Internal Revenue Code sections (IRC §) and their applicability to digital assets in the upcoming year. 

IRC § 475 mark-to-market election – Dealers in commodities and traders in securities and commodities 

IRC § 475 mark-to-market year-end reporting is mandatory for dealers in securities and an election is available to fair value crypto assets held by investment managers trading in securities and commodities. The primary benefit is characterizing marked-to-market downswings as ordinary losses rather than limited capital losses. 

Currently, the IRC § 475(f) election is available for dealers in commodities and traders in securities or commodities. The Biden administration had proposed modernizing tax rules to extend its applicability to digital assets. This topic will likely be revisited under the current Trump administration, which is looking to advance crypto-friendly policies in the financial industry as more institutions and investment managers diversify their portfolios to include digital assets. 

Digital assets are considered property for U.S. income tax purposes. Whether this asset class could be treated as a commodity for IRC § 475 purposes is based on an interpretation of the definition under IRC § 475(e) as a “commodity which is actively traded” and an interplay with the Commodity Futures Trading Commission’s (CFTC) designation of digital assets as commodities under the Commodity Exchange Act. 

This IRC §475 election and other sections applicable to investment securities and commodities may be expanded to include digital assets as its own separate class or possibly a hybrid instrument of the predecessors. 

Will IRC § 1091 wash sale rules apply to cryptocurrency? 

Generally, IRC § 1091 wash sales analysis is not required by fund managers who elect under IRC § 475. That said, a wash sale analysis is currently not required for crypto traders who dispose of a digital asset during market downswings and purchase a substantially identical digital asset within a 61-day period and realize capital losses. This disallowance of loss deduction under IRC § 1091 does not currently apply to digital assets which are considered property for IRS tax purposes rather than a security or commodity. 

IRC § 1091 wash sale rules were proposed on digital asset transactions to close the budget deficit under the Biden administration. It’s likely that any revised IRC § 475 expanded to include digital assets would also extend its definition to include the applicability of IRC § 1091 wash sale rules. 

IRC § 1061 gains – Carried interest on crypto investments 

The Biden administration proposed closing the loophole related to the capital gain treatment of carried interest for investment fund managers and treating it as ordinary income for taxpayers with more than $1 million in income. Under the current Trump administration, this tax loophole will likely remain intact, continuing the President’s implementation of previous tax cuts for certain individuals and institutional fund managers. 

Under IRC § 1061, carried interest earned by asset managers in respect to their “applicable partnership interest” is characterized as long-term capital gains if the interest in the underlying asset is held for a period of three years or longer. 

IRC § 1061 would apply to digital assets that were disposed of or sold in characterizing capital gain treatment. Proper reporting and tracking of digital asset acquisitions by fund managers on hard forks, air drops, staking and mining rewards is important to track the start of the three-year holding period. 

Tokenized real estate – Fractional ownership 

Real estate is leading the tokenized real-world asset (RWA) revolution by allowing investors to diversify their portfolios by holding fractions of real estate, creating opportunities for fractional ownership through increased accessibility and liquidity. 

Tokenized real estate is the digitization of property ownership and represents the blockchain equivalent of a tenancy-in-common arrangement, whereby co-owners are entitled to share in a piece of property and the rights to their proportionate share of rents or profits, transfer of interest and to demand a partition of the property. 

One of the benefits of a tenancy-in-common arrangement exists under Rev. Rul. 2002-22 which provides for an IRC § 1031 tax deferral of like-kind exchanges of property held for business or investment purposes. 

Does IRC § 1031 exchanges apply to fractionalized real estate tokens? 

Currently, IRC § 1031 only applies to exchanges of real property. Real property includes certain intangible assets further defined under Treasury Regs. § 1.1031(a)-3(a)(5) and if the intangible asset derives its value from real property or an interest in real property and is inseparable from that real property or an interest in real property. 

An interpretation of these regulations and general property principles might lend itself to include tokenized real estate property as real property for IRC § 1031 purposes. A real estate token represents a co-owner’s fractional ownership of an undivided property, and the token holder is entitled to their proportionate share of rents or profits derived from the underlying real property. 

For U.S. tax purposes, digital assets are considered property and a digital asset stored electronically can be bought, sold, owned, transferred or traded. Real estate tokens can currently be traded on tokenized platforms between investors with the transactions executed on-chain. Taxpayers engaging in similar transactions should obtain further professional advice on the applicability of IRC § 1031. 

What about IRC § 704(c) built-in gain on contributed property and IRC § 721 nonrecognition of gain or loss on contribution? 

Fractional property interests are often contributed to an operating partnership or a flow-through holding entity. Taxpayers should be cognizant of contributing 704(c) property if at the time of the contribution, the property’s fair market value differs from its adjusted basis. Appreciated gains on real estate tokens contributed to a partnership would similarly follow allocation rules under IRC § 704(c). Under this rule, the partnership needs to determine any built-in gain on the contributed real estate token to allocate any future gains on the sale of that token to the appropriate partner. 

Taxpayers contributing appreciated real estate tokens to a partnership should consider the application of IRC § 721 to ensure gain is not immediately recognized in the partnership. 

Traditional REITs vs tokenized real estate platforms 

Traditional equity REITs have offered investors the opportunity to invest in real estate through rental income and capital appreciation, and mortgage REITs provide investors with a stream of interest income. 

Tokenized real estate ownership would not fall under the IRC § 856 definition of a publicly traded REIT, but sometimes fractional property ownership can be structured in a public non-traded REIT. Although not currently heavily commercialized, tokenized ownership in these non-traded REITs may be the next step into modernizing traditional real estate investments. It will be interesting to see whether the current Trump administration will engage in asserting a more crypto-friendly real estate market. 

DeFi brokers and lending platforms 

DeFi brokers, generally referred to as “trading front-end service providers,” were included as part of the finalized Section 6045 regulations in late 2024 released by the Treasury Department. The final regulations require trading front-end service providers to file information returns and report gross proceeds upon effectuating sales or exchange transactions of digital assets for customers. 

Under the current Trump administration, Senator Cruz and Representative Carey have already filed a CRA resolution to overturn these reporting requirements by brokers that regularly provide services effectuating digital asset sales. If the rule is disapproved, this could potentially alleviate the reporting burden on digital asset centralized exchanges and custodial wallet service providers. 

Of importance to note is that under IRS Notice 2024-57, liquidity and staking pool providers operating in the DeFi space are not subject to reporting requirements for certain digital asset transactions under Section 6045. These include:  

• Exchanges of wrapped tokens 
• Liquidity and staking pool transactions 
• Digital asset lending.  

This notice grants relief due to the IRS’ lack of guidance on whether these transactions substantiate a realization event. 

Digital asset lending, colloquially known as “crypto loans,” allow a user to borrow funds against their crypto assets and lenders to earn interest on the loaned assets. Crypto loans denominated in stablecoins, like USDC, are becoming a popular product amongst the DeFi lending community. Lending arrangements executed on smart contract-based platforms allow lenders and borrowers to transfer digital assets automatically and securely with yields deposited directly to the lender’s account. 

Will IRC § 1058 securities lending rules apply to digital assets? 

Under IRC § 1058, no gain or loss is recognized by the transferor of securities if they receive the rights to securities identical to the securities transferred along with any interest earned under the exchange agreement. 

There is an argument that IRC § 1058 could apply to digital assets if the transferor of a digital asset is entitled to receive an identical digital asset and thus only recognizes yield (staking) on the transaction. This digital asset exchange would not be considered a purchase or sale when you lend out crypto. 

There is also ambiguity as to whether a taxable event occurs in liquid and staking token arrangements. Liquidity and staking pool transactions work similarly in that the transferor’s digital assets are supplied to a token pool on a smart contract-based platform. Traditional staking tokens are used to validate the blockchain’s proof-of-stake (PoS) consensus mechanism to further secure the network, and participants are awarded validation token rewards. During this predetermined lock-up phase, the transferor cannot sell or transfer their staked tokens. 

Liquidity staking allows users to earn token rewards by providing liquidity to other DeFi exchanges or lending protocols. The transferor receives a token that entitles them to redeem their share of deposited tokens in the liquidity pool of assets. 

Conclusion 

In an industry as dynamic and transformative as crypto, providing clarity amidst uncertainty and vision amidst volatility is essential. As regulatory frameworks evolve and new opportunities emerge, staying informed and proactive is crucial for navigating the complexities of the digital asset landscape.  

Steering the crypto space toward sustainable success and widespread adoption will require the ability to: 

• Adapt to changing market conditions 
• Advocate for responsible growth 
• Inspire trust 

Whether navigating tax implications, exploring tokenized assets or engaging with DeFi platforms, informed decision-making will be the key to unlocking the full potential of the digital economy.