The United States Internal Revenue Service (IRS) has issued a temporary relief measure that will impact the way crypto taxpayers are treated on centralized exchanges. Specifically, this ruling addresses a contentious issue related to accounting methods used by brokers to report sales of cryptocurrencies.
Initial IRS Rulings and Concerns
Prior to this latest development, the IRS had stated that if investors holding crypto assets with a Centralized Exchange (CeFi) broker failed to select their preferred accounting method, the broker would default to reporting sales using the First-In-First-Out (FIFO) method. FIFO is a widely used capital gains tax calculation method in the US, which assumes that the oldest cryptocurrency bought is sold first.
This approach can lead to higher capital gains for taxpayers, as it prioritizes selling older assets with lower cost bases before newer ones with higher values. As a result, crypto investors who hold their assets on centralized exchanges without selecting an alternative accounting method could inadvertently maximize their tax liability.
Impact of Defaulting to FIFO
Shehan Chandrasekera, head of tax at Cointracker, has expressed concerns about the potential consequences of defaulting to FIFO in a bull market. In an Xpost on December 31st, he stated:
"You won’t have to be locked into FIFO as before."
Chandrasekera warned that imposing this rule immediately could have been disastrous for many crypto taxpayers during a bull market. This is because investors might unintentionally sell their earliest purchased assets — those with the lowest cost basis — first, thereby unknowingly maximizing their capital gains.
Understanding the FIFO Method
Mark Thomas, a well-known crypto commentator, shed light on the implications of using FIFO in a January 1st 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 specific scenario, FIFO would mean long-term capital gains instead of short-term. This distinction is crucial for taxpayers, as it affects how their capital gains are taxed.
Temporary Relief and Timeline
To alleviate concerns among crypto investors, the IRS has introduced a temporary relief measure that will remain in effect until December 31st, 2025. During this period, brokers will not be required to default to FIFO if investors fail to select an alternative accounting method.
This reprieve is intended to provide brokers with sufficient time to support all accounting methods, including HIFO (Highest In, First Out) and Spec ID. Additionally, crypto taxpayers will be able to maintain their own records until the specified date.
Blockchain Association Takes Legal Action Against IRS
Just days before this latest development, the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on December 28th. The plaintiffs argued that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like Decentralized Exchanges (DEXs) are unconstitutional.
Once the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions and report their gross proceeds from crypto and other digital asset sales. The implications of these changes will be significant for both investors and exchanges alike.
Implications and Next Steps
The temporary relief measure provided by the IRS will undoubtedly be a welcome respite for many crypto taxpayers. However, it is essential to note that this reprieve only applies to sales on centralized exchanges until December 31st, 2025.
In the meantime, investors are advised to carefully review their accounting methods and consider consulting with tax professionals to ensure compliance with changing regulations. As the crypto market continues to evolve, one thing remains certain: the need for clear and effective guidance from regulatory bodies is paramount.
Additional Resources
For those interested in learning more about this topic or staying up-to-date on the latest developments, we recommend exploring the following resources:
- Cointracker: A leading platform for tracking cryptocurrency investments and providing tax-related insights.
- Blockchain Association: An organization dedicated to promoting blockchain technology and advocating for regulatory clarity.
By staying informed and proactive, crypto investors can navigate these changes with confidence and ensure compliance with evolving regulations.