Temporary Relief for Cryptocurrency Holders on Centralized Exchanges
The United States Internal Revenue Service (IRS) has recently issued a temporary relief for a rule that would have defaulted cryptocurrency holders on centralized exchanges to a less-than-ideal accounting method. This ruling, which was initially set to be implemented in 2027, has been postponed until December 31, 2025.
Initial IRS Rulings
The initial IRS rulings stated that if investors holding crypto assets with a CeFi (centralized finance) broker don’t select their preferred accounting method, such as HIFO (Highest In, First Out) or Spec ID, the broker will default to reporting sales using the FIFO (First-In, First-Out) method. FIFO is the default method for calculating capital gains tax in the US, which assumes that the oldest cryptocurrency bought is sold first, pushing up a taxpayer’s capital gains.
Impact of Defaulting to FIFO
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 stated that investors might unintentionally sell their earliest purchased assets – those with the lowest cost basis – first, thereby unknowingly maximizing their capital gains.
Consequences of Unknowingly Maximizing Capital Gains
Crypto commentator Mark Thomas explained in a recent Xpost that FIFO can be problematic for cryptocurrency holders. He said, "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.
Temporary Relief and Consequences for Brokers
The temporary relief applies to sales on centralized crypto exchanges until December 31, 2025. This gives brokers time to support all accounting methods. During this period, crypto taxpayers will be able to maintain their own records. Once 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.
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 December 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.
Reasons for the Lawsuit
The lawsuit highlights several reasons why the new regulations are problematic:
- Brokers must disclose information about taxpayers involved in digital asset transactions, which could lead to a loss of anonymity.
- Brokers must report their gross proceeds from crypto and other digital asset sales, which could create an administrative burden.
- The rules expand existing requirements to include platforms like DEXs, which may not have the same infrastructure as centralized exchanges.
Impact on Cryptocurrency Holders
The lawsuit filed by the Blockchain Association and the Texas Blockchain Council aims to protect the rights of cryptocurrency holders. If successful, it could prevent the IRS from enforcing these regulations, potentially saving investors from having to deal with the administrative burden of maintaining records for all their transactions.
Timeline for New Regulations
Here’s a timeline of when the new regulations are set to take effect:
- 2025: The temporary relief expires on December 31, and brokers must start reporting sales using the FIFO method if taxpayers don’t select their preferred accounting method.
- 2027: The rules requiring brokers to report digital asset transactions and expanding existing requirements to include platforms like DEXs are set to take effect.
