The United States Internal Revenue Service (IRS) has issued a temporary reprieve from a rule that would have defaulted crypto holders on centralized exchanges to a less-than-ideal accounting method. This decision is likely to provide some much-needed relief to investors who hold cryptocurrency assets with CeFi brokers.
Background: Initial IRS Rulings
As reported earlier, the initial IRS rulings stated that if investors holding crypto assets with a CeFi broker did not select their preferred accounting method, such as HIFO (Highest In, First Out) or Spec ID, the broker would default to reporting sales using the FIFO method. FIFO, also known as ‘First In, First Out,’ is the default method for calculating capital gains tax in the US. It assumes that the oldest cryptocurrency bought is sold first, which can push up a taxpayer’s capital gains.
Impact of Defaulting to FIFO Method
Cointracker’s head of tax, Shehan Chandrasekera, warned that imposing this rule immediately could have been disastrous for many crypto taxpayers during a bull market. He said that investors might unintentionally sell their earliest purchased assets – those with the lowest cost basis – first, thereby unknowingly maximizing their capital gains.
Consequences of Using FIFO Method
Crypto commentator Mark Thomas pointed out that while FIFO can be beneficial in certain situations, it is not always the best choice for crypto taxpayers. He said, ‘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: What it Means for Crypto Taxpayers
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 crypto taxpayers to maintain their own records until that date. This reprieve is likely to provide some much-needed breathing room for investors who hold cryptocurrency assets with CeFi brokers.
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 December 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. 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.
What this Means for Crypto Investors
The postponement of the default FIFO rule is a significant relief for crypto investors who hold assets with CeFi brokers. This temporary reprieve will give them time to adjust their accounting methods and ensure that they are not inadvertently maximizing their capital gains. However, it’s essential to note that this reprieve is only temporary, and crypto taxpayers must still comply with the IRS rules by December 31, 2025.
Conclusion
The IRS’s decision to postpone the default FIFO rule is a welcome relief for crypto investors who hold assets with CeFi brokers. This temporary reprieve will give them time to adjust their accounting methods and ensure that they are not inadvertently maximizing their capital gains. However, it’s essential to note that this reprieve is only temporary, and crypto taxpayers must still comply with the IRS rules by December 31, 2025.
Recommendations for Crypto Taxpayers
To take advantage of this temporary reprieve, crypto taxpayers should:
- Review their accounting methods: Ensure that they are using the most suitable accounting method for their investment portfolio.
- Maintain accurate records: Keep detailed records of their cryptocurrency transactions and holdings to ensure compliance with IRS rules.
- Consult a tax professional: Seek advice from a qualified tax professional to ensure that they are meeting their tax obligations.
By following these recommendations, crypto taxpayers can take advantage of the temporary reprieve and minimize their capital gains tax liability.
