Cryptocurrency

IRS Provides Temporary Relief on Cryptocurrency Cost Basis Method Changes

The United States Internal Revenue Service (IRS) has announced a temporary relief for a rule that would have defaulted crypto holders on centralized exchanges to the less-than-ideal accounting method, FIFO (First In, First Out). This decision comes as a welcome respite for cryptocurrency taxpayers who were facing the possibility of inadvertently maximizing their capital gains.

Table of Contents

What is FIFO and Why is it a Problem?

FIFO is the default method for calculating capital gains tax in the US. It assumes that the oldest cryptocurrency bought is sold first, which can lead to an increase in a taxpayer’s capital gains. As explained by Cointracker head of tax Shehan Chandrasekera, "You won’t have to be locked into FIFO as before." This means that crypto holders will no longer be forced to use this method, which can be detrimental to their financial situation.

The Potential Consequences of Imposing the Rule

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." This can lead to a significant increase in tax liabilities, which can be devastating for individuals who are not prepared.

The Temporary Relief

The temporary relief applies to sales on centralized crypto exchanges until December 31, 2025. This gives brokers time to support all accounting methods, including HIFO (Highest In, First Out) and Spec ID. During this period, crypto taxpayers will be able to maintain their own records, ensuring that they are not inadvertently maximizing their capital gains.

The Blockchain Association Takes Legal Action against the IRS

Just days after the announcement, the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on December 28. They argued 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 Take Effect in 2027

Once the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions. They must also report their gross proceeds from crypto and other digital asset sales. This will require significant changes to the way that brokers operate and may lead to increased compliance costs.

Expert Opinions on FIFO

Mark Thomas, a well-known crypto commentator, had the following to say about FIFO: "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, he noted that this scenario is rare and that most investors will not benefit from using FIFO.

Conclusion

The temporary relief announced by the IRS is a welcome development for cryptocurrency taxpayers who were facing the possibility of inadvertently maximizing their capital gains. The postponement of the default rule gives brokers time to support all accounting methods, ensuring that crypto holders can maintain control over their financial situation. However, it remains to be seen whether the rules requiring brokers to report digital asset transactions will withstand legal challenge.

Key Takeaways

The IRS has postponed the default rule for cryptocurrency holders on centralized exchanges.
The temporary relief applies to sales on centralized crypto exchanges until December 31, 2025.
Brokers must support all accounting methods during this period.
Crypto taxpayers will be able to maintain their own records.
The Blockchain Association and the Texas Blockchain Council have filed a lawsuit against the IRS.
The rules requiring brokers to report digital asset transactions take effect in 2027.

Additional Reading

IRS DeFi Broker Rule ‘Absolutely Should Be Challenged,’ Says Uniswap CLO: The article explores the implications of the IRS’s decision on decentralized exchanges and argues that it is unconstitutional.
Down to $200 one day, Pixels founder had $2.4M the next: Luke Barwikowski, X Hall of Flame: This article highlights the volatility of the crypto market and the importance of maintaining accurate records.

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