Anchor Your Crypto Ship in the IRS Safe Harbor

Here are some final thoughts on IRS Rev. Proc. 2024-28 while you anchor for the holidays. The IRS introduced transitional guidance to help taxpayers shift from universal method of tracking and calculating gains and losses to wallet by wallet method before January 1, 2025. This is a little bit like taking the airplane apart in mid air and putting it back together again. 

If you follow the guidance you can get the coveted IRS safe harbor, which is loosely like bullet-proof glass from the audit gun of the IRS. However, the IRS didn't exactly make clear what the safe harbor provides. 

PITFALL

Everyone in crypto knows the tracking and tax calculations is a nightmare and most people take many months of the following year (in 2025, for example, for 2024 tax returns) to complete the exercise. The safe harbor forces taxpayers to complete their 2024 Form 8949 gains and losses BEFORE the end of the year and BEFORE completing the safe harbor allocations. 

This is a double whammy gotcha. Now you have two major things to do before year end. 

1. Review your crypto tax software and complete your 8949 gains and loses calculation.
2. After #1 above, complete the cost basis allocation exercise for the safe harbor.

Watch my interview with Andreas Antonopoulos on this subject. We cover many of the nuances of this one-time allocation exercise, but I subsequently thought of the "cart before the horse" pitfall.

Here's what you need to know: 

Key changes

1. The "universal method" for calculating crypto gains and losses is being eliminated.
2. Reporting will now be done on a wallet-by-wallet or account-by-account basis.
3. Centralized exchanges will issue 1099-DA forms, similar to the 1099-B for traditional securities. These forms will most likely be incorrect. (this is part of the digital asset broker final regs but it's tangentially related to the cost basis exercise. 

Why it matters

These changes aim to close the "tax gap" - the difference between expected and actual tax revenue. The tax study was the basis for justifying another set of onerous regulations. Taxpayers drew the short end of the stick. If you don't meet the safe harbor:

• The IRS could potentially challenge your prior year's tax calcs. 
• An audit could result in a massive tax bill if the IRS says your HIFO should have been FIFO 
• You may have to hire a CPA or tax attorney to sort it out with the IRS

5 steps to take now

1. Consolidate assets: Reduce the number of wallets per asset type.
2. Remove assets from centralized exchanges: This allows for "cost basis cleansing" which is also part of consolidation. 
3. Simplify your holdings: Consider focusing on pure assets and simplifying complex stuff like staking, LP positions and so on (where practical). Generally crypto software will more likely track basis correctly this way. 
4. Document your tax basis: Download and correct reports showing your tax basis for all assets.
5. Timestamp your documentation: Use opentimestamps.org to prove the timing of your declaration. Use protonmail if you choose to email yourself. (Thanks Andreas for highlighting opentimestamp.) 
   
   

Key Takeaway

Your crypto tax software may provide a wallet by wallet report, but it may only provide an asset summary rather than detailed tax lots, for example. You may end up with sub par documentation so write up a memo of all the steps you took to show good faith and the limitations you faced doing the exercise. 

Additional considerations

• The definition of a "wallet" for tax purposes is likely at the "address" level because that's how the  software tracks. 
•  Even if you've only purchased and never sold, you may still need to document. 

Remember, these steps are general guidelines. Consult with a tax professional to ensure compliance with your specific situation. Don't wait - the deadline is approaching fast. Take action now to CYA your crypto cost basis so you can anchor your crypto ship in the safe harbor.

As always, your goal is to get a Crypto Bullseye™.

Yours in crypto,

Kirk David Phillips, CPA, CMA, CFE, CBP