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 is seen as a welcome respite for cryptocurrency investors who were set to face higher capital gains taxes due to the imposition of the FIFO method.
Initial IRS Rulings
The initial IRS rulings stated that if investors holding crypto assets with a CeFi (centralized finance) broker didn’t 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. The FIFO method is the default method for calculating capital gains tax in the US and is calculated by assuming that the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains.
Impact of Defaulting to FIFO Method
The imposition of the FIFO method without allowing investors to select their preferred accounting method could have had disastrous consequences 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.
Temporary Relief for Crypto Taxpayers
The temporary relief applies to sales on centralized crypto exchanges until December 31, 2025, giving brokers time to support all accounting methods. This means that crypto taxpayers will be able to maintain their own records until the specified date. The Blockchain Association and the Texas Blockchain Council had filed a lawsuit against the IRS just days before this update, arguing that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
FIFO Method: Pros and Cons
The FIFO method can have both positive and negative effects on crypto taxpayers. Crypto commentator Mark Thomas said in a January 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. However, Thomas also noted that this method can be problematic for investors who sell their assets before meeting the one-year threshold.
The Consequences of Imposing FIFO Method
The imposition of the FIFO method without allowing investors to select their preferred accounting method could have had significant consequences for crypto taxpayers. By defaulting to FIFO, brokers would report sales using this method, which could lead to higher capital gains taxes for investors. This could also result in a loss of control over how their assets are reported and taxed.
The Blockchain Association Takes Action Against IRS
Just days before the update, the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS arguing that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional. The Blockchain Association has been vocal in its opposition to these rules, citing concerns over the impact on crypto taxpayers.
What This Means for Crypto Taxpayers
The temporary relief provided by the IRS is a welcome respite for crypto investors who were set to face higher capital gains taxes due to the imposition of the FIFO method. However, this reprieve is only temporary and brokers must still support all accounting methods by December 31, 2025. Crypto taxpayers will be able to maintain their own records until that date.
Conclusion
The IRS has issued a temporary relief for crypto holders on centralized exchanges, providing a welcome respite from the imposition of the FIFO method. This move is seen as a positive development for cryptocurrency investors who were set to face higher capital gains taxes due to the defaulting to FIFO. However, the Blockchain Association and other industry players continue to push back against the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs).
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