It’s no secret that the IRS is stepping up its compliance efforts when it comes to digital asset reporting. The agency released regulations this year requiring crypto brokers to file tax forms (Form 1099-DA) reporting the sale of customers’ digital assets. These new regulations are anticipated to start on January 1, 2025.
Among many significant changes to crypto tax reporting, some of the most important are changes to cost basis calculations. Previously, taxpayers could use the universal wallet method to track their digital asset cost basis, but this is no longer allowed under the new regulations. Starting January 1, 2025, taxpayers must instead use the wallet-by-wallet method.
Gordon Law is a law firm that helps crypto investors comply with their tax obligations. Our team of experienced crypto tax attorneys can assist with cost-basis tracking and reporting your crypto transactions.
2025 is quickly approaching, so let’s dive into what crypto investors need to know about the new cost-basis tracking method so you can get ready.
Old Cost Basis Method: Universal Tracking
When the IRS started requiring the reporting of crypto sales for tax purposes, the guidance said that taxpayers must match a sale of an asset to a buy of that asset. The IRS only specified that taxpayers must use First-In-First-Out (FIFO) or Specific ID.
Taxpayers could track their crypto cost basis for tax purposes as if their assets were held in a single account, even if the assets were actually held in multiple accounts (such as multiple exchanges or wallets). This is commonly referred to as the universal method.
When a taxpayer sells a digital asset held in one of their wallets using the universal method for tracking, the cost basis of that asset is stored in a pool and matched to an asset when it’s sold based on the taxpayer’s inventory method. So, in theory, the cost basis of an asset in one wallet can be applied to the sale of an asset in another.
Let’s look at an example to understand how this works. Suppose you hold 10 ETH that you purchased at different times over the past few years across 15 different wallets and accounts. The total cost of the ETH you purchased is stored in a theoretical pool. Your cryptocurrency inventory method is FIFO.
You sell 2 ETH from one of your digital wallets. Using the universal method for cost basis tracking, your basis of the 2 ETH is the cost of the earliest purchased ETH in your ETH cost basis pool. The basis is not necessarily the purchase price of the specific 2 ETH held in the wallet from which you sold it. It could have come from any number of your wallets or accounts.
New Cost Basis Method: Wallet-by-Wallet Tracking
As the name suggests, wallet-by-wallet tracking requires taxpayers to track the cost basis of their digital assets held in each wallet. So, if you sell 2 ETH from a specific wallet and use the FIFO inventory method, the basis for calculating the gain on the sale of the ETH is the cost basis of the 2 earliest purchased ETH in that wallet.
Switching from Universal to Wallet-by-Wallet Tracking
Under the universal method, allocation of the asset basis does not happen until the taxpayer sells the asset. Accordingly, taxpayers using this method hold assets with no basis allocated to them. Since universal tracking is no longer permissible, taxpayers must allocate their total cost basis to each of their assets held in each wallet or account.
Recognizing that taxpayers need time to switch to wallet-by-wallet tracking, the IRS is offering transitional relief so they can make appropriate changes to their portfolios. This is detailed in IRS Rev. Proc. 2024-28. Taxpayers have until January 1, 2025, to reasonably allocate their unused cost basis to the assets they hold.
A reasonable allocation can be completed using one of two options: the global allocation method or the specific unit allocation method.
- Global Allocation: Taxpayers can allocate their basis to all their remaining assets using a specific rule. This is generally a simpler method.
- Specific Unit Allocation: Taxpayers can allocate the unused basis across all assets held in a single account or allocate the basis to specific assets held in that account. With some strategic year-end accounting, you can use this to your advantage. Before Dec. 31, you can move assets with a high cost basis into your active trading accounts, and move assets with a low cost basis to cold wallets for long-term storage.
Once you set your allocation, you cannot change it. You must also keep accurate records of their basis and assets.
What Happens Going Forward When You Sell a Digital Asset?
Since universal wallet tracking will no longer be allowed, taxpayers must track the cost basis of their digital assets by account. When a digital asset is sold, the taxpayer either needs to specifically identify the asset sold prior to or at the time of sale or default to the FIFO method.
Taxpayers not defaulting to the FIFO method can implement a rule for determining which asset they sell from each wallet or account. You can always reach out to our team for help.
How to Prepare
Taxpayers holding digital assets should first learn how they are currently tracking their digital asset basis and if they need to make any updates prior to January 1, 2025.
For those using crypto software already to calculate their capital gains, the software may have the capability for the taxpayer to reasonably allocate their basis and make the switch from universal tracking. Taxpayers should consult their software provider for logistical guidance.
Investors not currently working with a crypto tax professional to help with their compliance obligations should consider reaching out to one to discuss their options as soon as possible since the IRS’ deadline is approaching quickly.
How Gordon Law Can Help
If you need assistance allocating your cost basis or want to discuss your options, Gordon Law can advise you on the most tax-efficient way to switch your tracking method. Remember, there is a deadline for this, and you don’t want to wait until the last minute. Get in touch with us today to see how we can assist you.
