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 move comes as a welcome respite for many cryptocurrency investors who were facing the possibility of being locked into the First In, First Out (FIFO) method for calculating capital gains tax.
The Initial Ruling and Its Potential Consequences
Prior to this temporary relief, the IRS had stated that if investors holding crypto assets with a CeFi broker didn’t select their preferred accounting method, like HIFO (Highest In, First Out) or Spec ID, the broker would default to reporting sales using the FIFO method. FIFO is the default method for calculating capital gains tax in the US and is calculated by assuming the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains.
The Problem with FIFO
As Shehan Chandrasekera, head of tax at Cointracker, pointed out in a December 31 Xpost, 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.
The Potential Consequences of FIFO
Crypto commentator Mark Thomas explained in a January 1 Xpost that while FIFO can be beneficial in certain situations, it’s not always the best choice. According to Thomas, "FIFO, in this case, would mean long-term capital gains instead of short-term." However, Thomas noted that FIFO is most beneficial when the sale date is more than one year after the earliest crypto you bought but less than one year after the latest crypto you bought.
Temporary Relief for Cryptocurrency Holders
The temporary relief applies to sales on centralized crypto exchanges until December 31, 2025. This gives brokers time to support all accounting methods and allows cryptocurrency taxpayers to maintain their own records until that date.
Blockchain Association Takes Legal Action Against IRS
This update comes just days after the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on December 28. The lawsuit argues that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
The Rules and Their Consequences
Once the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions. Brokers must also report their gross proceeds from crypto and other digital asset sales. This could have significant consequences for cryptocurrency investors who don’t properly plan for capital gains tax.
Why This Matters
This temporary relief is a welcome development for many cryptocurrency holders who were facing the possibility of being locked into the FIFO method. However, it’s essential to understand that this is only a temporary reprieve and that the long-term consequences of these rules could be far-reaching.
What You Can Do Now
To avoid any potential issues with capital gains tax, cryptocurrency investors should take steps now to ensure they have a clear understanding of their accounting methods. This includes selecting a preferred accounting method like HIFO or Spec ID and maintaining accurate records of their crypto transactions.
Conclusion
The temporary relief for cryptocurrency holders on centralized exchanges is a positive development that gives brokers time to support all accounting methods. However, it’s essential to remember that this is only a temporary reprieve and that the long-term consequences of these rules could be far-reaching. To avoid any potential issues with capital gains tax, cryptocurrency investors should take steps now to ensure they have a clear understanding of their accounting methods.
References
- Shehan Chandrasekera’s Xpost on December 31
- Mark Thomas’ Xpost on January 1
- The Blockchain Association and Texas Blockchain Council’s lawsuit against the IRS on December 28
Additional Resources
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