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 comes as a welcome respite for investors who were facing the prospect of increased capital gains tax liability.
What is FIFO and Why is it a Concern for Crypto Taxpayers?
FIFO, or 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, pushing up a taxpayer’s capital gains. This can be particularly problematic for crypto investors who have purchased and sold multiple assets over time.
Shehan Chandrasekera Weighs in on the Implications of FIFO
Cointracker head of tax Shehan Chandrasekera warns that imposing this rule immediately could have been disastrous for many crypto taxpayers during a bull market. "You won’t have to be locked into FIFO as before," he said in a Dec. 31 Xpost.
Chandrasekera emphasized the potential consequences of using FIFO, stating that investors might unintentionally sell their earliest purchased assets – those with the lowest cost basis – first, thereby unknowingly maximizing their capital gains. This could result in increased tax liability for crypto holders who are not aware of the implications of using this method.
Mark Thomas Provides an Alternative Perspective on FIFO
Crypto commentator Mark Thomas offered a different perspective on the use of FIFO. In a Jan. 1 Xpost, he stated that "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."
Thomas pointed out that in this specific scenario, using FIFO would mean long-term capital gains instead of short-term. This distinction is crucial for crypto taxpayers who are trying to minimize their tax liability.
Temporary Relief and What it Means for Crypto Taxpayers
The temporary relief applies to sales on centralized crypto exchanges until Dec. 31, 2025. During this time, brokers will be given the opportunity to support all accounting methods, allowing crypto taxpayers to maintain their own records without being defaulted into FIFO.
Blockchain Association Takes Legal Action Against IRS
Just days after the IRS issued the temporary relief, the Blockchain Association and the Texas Blockchain Council filed a lawsuit against the IRS on Dec. 28. The lawsuit argues that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
The update comes as a significant development in the ongoing saga between the IRS and crypto taxpayers. As the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions and report their gross proceeds from crypto and other digital asset sales.
Implications of the Lawsuit for Crypto Taxpayers
The lawsuit filed by the Blockchain Association and the Texas Blockchain Council has significant implications for crypto taxpayers. If successful, it could potentially roll back or modify the rules requiring brokers to report digital asset transactions and expand existing requirements.
What this Means for Crypto Investors
For crypto investors, this temporary relief is a welcome respite from the potential consequences of using FIFO as the default accounting method. It provides a window of opportunity for brokers to support all accounting methods and allows crypto taxpayers to maintain their own records until Dec. 31, 2025.
However, the implications of the lawsuit filed by the Blockchain Association and the Texas Blockchain Council are far-reaching and could potentially impact the way that crypto transactions are reported in the future.
What You Need to Know About FIFO
FIFO is a method for calculating capital gains tax in the US. It assumes that the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains.
- How does FIFO work?: FIFO calculates capital gains by assuming that the oldest cryptocurrency bought is sold first.
- What are the implications of using FIFO?: Using FIFO can result in increased tax liability for crypto holders who are not aware of the implications of this method.
- Is there an alternative to FIFO?: Yes, there are alternative accounting methods available, such as HIFO (Highest In, First Out) and Spec ID.
How to Minimize Tax Liability with Crypto Transactions
For crypto taxpayers looking to minimize their tax liability, it is essential to understand the implications of using different accounting methods. By maintaining accurate records and selecting the most favorable method, crypto holders can reduce their tax liability and avoid unexpected surprises.
The temporary relief issued by the IRS provides a welcome respite for crypto investors who were facing the prospect of increased capital gains tax liability. However, the implications of the lawsuit filed by the Blockchain Association and the Texas Blockchain Council are far-reaching and could potentially impact the way that crypto transactions are reported in the future.
As the rules take effect in 2027, brokers must disclose information about taxpayers involved in digital asset transactions and report their gross proceeds from crypto and other digital asset sales. Crypto investors would do well to stay informed and adapt to any changes that may arise in the world of crypto taxation.
Recommended Reading
- IRS DeFi Broker Rule ‘Absolutely Should Be Challenged,’ Says Uniswap CLO: In this article, we explore the implications of the IRS rule requiring brokers to report digital asset transactions and expand existing requirements.
- Down to $200 one day, Pixels founder had $2.4M the next: Luke Barwikowski, X Hall of Flame: This article highlights the risks and uncertainties associated with investing in cryptocurrencies and the importance of maintaining accurate records.
Subscribe to Our Crypto Biz Newsletter
Stay up-to-date on the latest trends and developments in blockchain and crypto. Our weekly newsletter provides a snapshot of key business trends in this rapidly evolving space. Subscribe today to gain valuable insights and spot financial opportunities.