The United States Internal Revenue Service (IRS) has issued a temporary relief for a rule that would have defaulted crypto holders on centralized exchanges to a less-than-ideal accounting method. This development comes as a welcome respite for investors who were concerned about the potential consequences of the initial IRS ruling.
Understanding the Initial IRS Ruling
The initial IRS rulings stated that if investors holding crypto assets with a CeFi broker don’t select their preferred accounting method, like HIFO (Highest In, First Out) or Spec ID, the broker will default to reporting sales using the FIFO method. FIFO, otherwise known as ‘First In, First Out,’ is the default method for calculating capital gains tax in the US. It is calculated by assuming the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains.
The Consequences of Using FIFO
Imposing the FIFO rule immediately could have been disastrous for many crypto taxpayers during a bull market. Cointracker head of tax Shehan Chandrasekera warned that this would be because investors might unintentionally sell their earliest purchased assets — those with the lowest cost basis — first, thereby unknowingly maximizing their capital gains.
The Problem with FIFO
Crypto commentator Mark Thomas said in a Jan. 1 Xpost, ‘The one time that FIFO can be good is if your sale date is more than one year after the earliest crypto you bought, but less than one year after the latest crypto you bought.’ In this case, FIFO would mean long-term capital gains instead of short-term.
Temporary Relief for Crypto Taxpayers
The temporary relief applies to sales on centralized crypto exchanges until Dec. 31, 2025, in order to give brokers time to support all accounting methods. This means that crypto taxpayers will be able to maintain their own records until that date.
Blockchain Association Takes Legal Action Against IRS
The update comes just days after the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on Dec. 28, arguing that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
What’s at Stake
Once the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions. The brokers must also report their gross proceeds from crypto and other digital asset sales. This could have significant implications for crypto investors who are not prepared to handle the tax reporting requirements.
The Importance of Tax Planning
As we discussed earlier, the FIFO method can be detrimental to crypto taxpayers during a bull market. It is essential that investors plan ahead and select their preferred accounting method to avoid unintentionally maximizing their capital gains. With the temporary relief provided by the IRS, brokers have time to support all accounting methods, allowing taxpayers to maintain control over their tax reporting.
The Future of Crypto Taxation
The lawsuit filed by the Blockchain Association and the Texas Blockchain Council highlights the importance of ensuring that crypto taxation rules are fair and reasonable. The outcome of this case will likely have far-reaching implications for the crypto industry, and it is essential that investors stay informed about any developments in this area.
Conclusion
In conclusion, the temporary relief provided by the IRS is a welcome respite for crypto taxpayers who were concerned about the potential consequences of the initial ruling. However, it is essential that investors plan ahead and select their preferred accounting method to avoid unintentionally maximizing their capital gains. With the future of crypto taxation still uncertain, it is crucial that investors stay informed about any developments in this area.
Recommendations for Crypto Taxpayers
- Select Your Preferred Accounting Method: Choose a suitable accounting method like HIFO or Spec ID to ensure that you are not defaulted to FIFO.
- Maintain Accurate Records: Keep accurate records of your crypto transactions, including the cost basis and sale date.
- Stay Informed: Stay up-to-date with any developments in crypto taxation rules and regulations.
Resources for Crypto Taxpayers
- IRS Website: Visit the IRS website to learn more about tax reporting requirements for digital assets.
- Blockchain Association: Follow the Blockchain Association on social media or visit their website to stay informed about any updates on crypto taxation rules.
- Crypto Tax Software: Utilize crypto tax software like Cointracker or CryptoTax to simplify your tax reporting and ensure compliance with regulations.
By following these recommendations and staying informed, crypto taxpayers can navigate the complex world of crypto taxation and avoid unintentionally maximizing their capital gains.