Temporary Relief for Crypto Holders on Centralized Exchanges
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.
Initial IRS Rulings
Initially, the IRS ruled 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. This means that instead of choosing a specific accounting method, the broker would automatically use the FIFO method to calculate capital gains tax.
What is FIFO?
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. This can be problematic for crypto investors, as it may lead to unintended consequences.
Potential Issues with FIFO
Cointracker head of tax Shehan Chandrasekera warned that imposing this rule immediately could have been disastrous for many crypto taxpayers during a bull market. He stated that investors might unintentionally sell their earliest purchased assets – those with the lowest cost basis – first, thereby unknowingly maximizing their capital gains.
The Risks of Unintentional Capital Gains
Crypto commentator Mark Thomas pointed out that FIFO can be problematic in certain situations. 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, using FIFO would mean long-term capital gains instead of short-term.
Temporary Relief and Its Implications
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. Crypto taxpayers will be able to maintain their own records until that date.
The Blockchain Association Takes Action Against the 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.
Implications of the Lawsuit
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 Does This Mean for Crypto Investors?
The temporary relief is a welcome respite for crypto investors who would have been defaulted to the FIFO method. However, it’s essential to note that this relief only applies until Dec. 31, 2025, at which point brokers will be required to support all accounting methods.
Maintaining Records and Choosing Accounting Methods
Crypto taxpayers will need to maintain their own records and choose their preferred accounting method until the deadline. It’s crucial for investors to understand the implications of choosing a specific accounting method and how it may affect their capital gains tax.
The Importance of Understanding Tax Implications
As the crypto market continues to evolve, it’s essential for investors to stay informed about tax implications. This includes understanding the differences between various accounting methods and how they can impact capital gains tax.
Conclusion
The temporary relief provided by the IRS is a step in the right direction for crypto holders on centralized exchanges. However, it’s crucial that investors maintain their own records and choose their preferred accounting method to avoid any potential issues with FIFO.
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By staying informed about tax implications and understanding the differences between various accounting methods, crypto investors can make informed decisions and navigate the complex world of cryptocurrency taxation.
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