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. 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.
Understanding 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 holders, especially during bull markets.
The Potential Consequences of FIFO
Cointracker head of tax Shehan Chandrasekera warned that imposing this rule immediately could have been disastrous for many crypto taxpayers. 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 Role of Accounting Methods
In an Xpost on Dec. 31, Chandrasekera noted that this would be a significant issue for crypto taxpayers during a bull market. He emphasized that not having to be locked into FIFO as before is a welcome relief.
The Benefits and Drawbacks of FIFO
Crypto commentator Mark Thomas weighed in on the matter in an Xpost on Jan. 1, saying, ‘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, he noted, FIFO would mean long-term capital gains instead of short-term.
Temporary Relief and the Future of Crypto Taxation
The temporary relief applies to sales on centralized crypto exchanges until Dec. 31, 2025. This gives brokers time to support all accounting methods. During this period, crypto taxpayers will be able to maintain their own records.
Blockchain Association Takes Action Against IRS
The update comes just days after the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on Dec. 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.
What’s Next for Crypto Taxation?
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.
The Importance of Proper Accounting Methods
In conclusion, the temporary relief provided by the IRS is a welcome respite for crypto holders on centralized exchanges. It highlights the importance of proper accounting methods in calculating capital gains tax. As the rules take effect in 2027, it will be crucial for brokers and taxpayers alike to understand the implications of these changes.
The Future of Crypto Taxation
The Blockchain Association’s lawsuit against the IRS raises important questions about the constitutionality of these rules. If successful, this could have significant implications for the future of crypto taxation.
Maintaining Records and Supporting Accounting Methods
During the temporary relief period, it is essential for taxpayers to maintain their own records and support all accounting methods. This will help ensure compliance with the new rules and minimize any potential issues.
The Role of Blockchain in Crypto Taxation
The integration of blockchain technology into crypto taxation has the potential to improve transparency and efficiency. However, it also raises concerns about privacy and data protection.
Conclusion
In conclusion, the temporary relief provided by the IRS is a significant development in the world of crypto taxation. It highlights the importance of proper accounting methods and the need for brokers and taxpayers alike to understand the implications of these changes.
Additional Reading:
- Down to $200 one day, Pixels founder had $2.4M the next: Luke Barwikowski, X Hall of Flame
- Magazine: Crypto Biz newsletter – Weekly snapshot of key business trends in blockchain and crypto, from startup buzz to regulatory shifts
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