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. This development comes as a significant reprieve for investors who hold cryptocurrencies with CeFi brokers.
Initial IRS Rulings and the FIFO Method
According to the initial IRS rulings, 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. FIFO, otherwise known as ‘First In, First Out,’ is the default method for calculating capital gains tax in the US.
The FIFO method calculates capital gains by assuming that the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains. This method has been criticized for being inadequate and potentially disastrous for many crypto taxpayers during a bull market.
Shehan Chandrasekera Weighs In
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 said 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.’
Chandrasekera’s warning highlights the potential risks associated with the FIFO method, particularly in a bull market where prices are increasing rapidly. By defaulting to the FIFO method, investors may inadvertently maximize their capital gains, leading to unexpected tax liabilities.
Mark Thomas on FIFO and Its Limitations
Crypto commentator Mark Thomas also weighed in on the FIFO method, stating 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.’ In this specific scenario, Thomas noted that FIFO would mean long-term capital gains instead of short-term.
Thomas’s comment highlights a crucial limitation of the FIFO method. While it may be suitable in certain situations, it can lead to unintended consequences and tax liabilities for many investors.
Temporary Relief for Crypto Taxpayers
The temporary relief issued by the IRS applies to sales on centralized crypto exchanges until Dec. 31, 2025. During this period, brokers will not default to the FIFO method, allowing taxpayers to maintain their own records and select their preferred accounting method.
This reprieve gives brokers time to support all accounting methods, ensuring that investors can choose the most suitable method for their specific needs. The temporary relief also acknowledges the complexities of cryptocurrency taxation and the need for a more nuanced approach.
Blockchain Association Takes Legal 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, arguing that the rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like decentralized exchanges (DEXs) are unconstitutional.
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. This development highlights the ongoing debate surrounding cryptocurrency regulation and taxation.
Implications of the Temporary Relief
The temporary relief issued by the IRS has significant implications for crypto holders on centralized exchanges. By giving brokers time to support all accounting methods, investors can maintain control over their tax obligations and choose the most suitable method for their specific needs.
This reprieve also acknowledges the complexities of cryptocurrency taxation and the need for a more nuanced approach. The temporary relief is a welcome development for investors who hold cryptocurrencies with CeFi brokers, providing them with much-needed breathing space in an increasingly complex regulatory landscape.
Conclusion
The IRS’s temporary relief for crypto holders on centralized exchanges marks a significant development in the ongoing debate surrounding cryptocurrency taxation. By giving brokers time to support all accounting methods, investors can maintain control over their tax obligations and choose the most suitable method for their specific needs.
As the cryptocurrency market continues to evolve, it is essential that regulatory bodies acknowledge the complexities of cryptocurrency taxation and provide clear guidelines for investors. The temporary relief issued by the IRS is a step in the right direction, providing much-needed clarity and flexibility for crypto holders on centralized exchanges.
