Important Crypto Tax Update: Preparing for the 2025 IRS Cost Basis Rules & Utilizing the Safe Harbor Plan
Important Crypto Tax Update: Preparing for the 2025 IRS Cost Basis Rules & Utilizing the Safe Harbor Plan
A significant change is coming for how the IRS requires us to track and report cryptocurrency transactions. Starting in 2025, more stringent cost basis reporting rules go into effect, and it's crucial that you understand what you need to do before January 1st, 2025 to comply and potentially mitigate tax liabilities. These new rules will require more diligence in tracking your crypto than ever before, particularly if you use multiple wallets or exchanges.
The 2025 IRS Crypto Cost Basis Rules: More Complex Than You Think
Currently, the IRS allows for some flexibility in how we determine the cost basis of our cryptocurrency when we sell, trade, or otherwise dispose of it. However, starting with the 2025 tax year, the IRS will require more precise and specific identification of the assets being sold. This means you need to know exactly when you acquired specific units of a cryptocurrency and their individual cost basis. No more general "FIFO" (First In, First Out) assumptions or averages.
The Challenge of Multiple Wallets and Exchanges
If you're like many crypto users, you probably don't keep all of your assets in a single location. You may have:
Multiple Exchanges: You might buy and sell crypto on different platforms (e.g., Coinbase, Binance, Kraken).
Hardware Wallets: You might store some of your holdings offline using wallets like Ledger or Trezor.
Software Wallets: You might use apps like MetaMask, Trust Wallet, or others for various purposes.
DeFi Platforms: You might have assets locked in staking, lending, or other decentralized finance protocols.
The implication of this is that each asset within each wallet and exchange will need to be tracked with its own specific cost basis. This means that 1 BTC in one wallet could have a different cost basis than 1 BTC in another wallet. It's not enough to just know you have 2 BTC; you have to know the details for each individual BTC and when it was acquired.
Why is This a Big Deal?
Without proper records, you could:
Overpay on Taxes: If you can't identify your highest-cost assets for sale, you may inadvertently sell your lowest-cost assets, resulting in higher capital gains taxes.
Face IRS Penalties: Incorrect or incomplete cost basis reporting can lead to audits and penalties.
Spend Hours Reconstructing History: Trying to piece together your transaction history after the fact can be extremely time-consuming and error-prone.
The Safe Harbor Plan: Your Solution
Fortunately, the IRS has introduced a solution: the Safe Harbor Rule (as outlined in Rev Proc 2024-28). This rule allows you to retroactively designate specific units of cryptocurrency and their associated costs, if you have a documented plan in place. This plan allows you to specify the units of crypto that you sold as long as you consistently follow the plan.
Key Takeaways Regarding the Safe Harbor Plan (Based on Andrew Gordon's Insights):
The Plan is a MUST: To use the Safe Harbor rule, you must have a documented plan in place prior to January 1st, 2025 and demonstrate you have consistently followed that plan.
What Needs to be in the Plan:
Detailed Inventory: A detailed record of the crypto assets you hold, including dates of purchase, cost basis, amounts, and location of the asset. This plan can be specific, so if you have crypto that will likely never be sold, they are not required to be included. However, you must account for every asset that may be sold.
Method of Identification: Your method of identifying the units sold. For instance, you must choose which methodology you will utilize, such as High Cost Basis, Low Cost Basis, Last In First Out, etc. You must consistently use your stated method. You must have a plan for how you determine your cost basis before sale.
Date-Stamping/Time Stamping: Use a time-stamping service to provide third-party proof that you created and signed your plan prior to the deadline. (See the link for OpenTimestamps below.)
Andrew Gordon emphasizes using time-stamping services like OpenTimestamps to prove your plan’s existence and timestamp before the deadline. This serves as a record to show to the IRS if they require it.
What You Need to Do NOW – Before January 1, 2025:
Create Your Digital Asset Allocation Plan: Don't wait until the last minute! Utilize the resources available (see below) to prepare your plan. This is your official document, your plan of record, and it's required in order to utilize Safe Harbor.
Document your current cryptocurrency holdings: Download your transaction history from all exchanges, hardware wallets and other sources. Reconcile these records with your bank records and other transaction details.
Choose a method for identification of cryptocurrency sold: Understand the financial implications of selling high-cost crypto vs. low-cost crypto. Consistency is key. Once you've made a choice, you need to stick with it.
Time-Stamp Your Plan: Use a service like OpenTimestamps to establish a verifiable date for your plan's creation. This is a very important step.
Maintain Excellent Records Going Forward: Continue to meticulously document all of your crypto transactions, including purchase dates, costs, sale dates, and wallet/exchange locations.
Consider using Tax Preparation Software: Services like Koinly.io (and others) can help you import your transaction history from various sources and calculate your cost basis. This can save you significant time and reduce the chance of errors. However, it's still very important to understand the Safe Harbor rule.
Resources to Help You:
Andrew Gordon YouTube Explanation: https://youtu.be/wT-qhbNdGK0?si=XhOecCVDy2i7b86d
OpenTimestamps: https://opentimestamps.org/
CryptoTaxGirl Explanation: https://youtu.be/oaJh6k1QoPk?si=YGQsDuCtOpeAX9-S
CryptoTaxGirl Blog Post: https://cryptotaxgirl.com/blog/understanding-the-safe-harbor-plan-rev-proc-2024-28-and-2025-crypto-tax-reporting-updates/
CryptoTaxGirl Safe Harbor Instructions: https://cryptotaxgirl.com/blog/safe-harbor-instructions/
CryptoTaxGirl Digital Asset Allocation Plan (Template): https://cryptotaxgirl.com/wp-content/uploads/2024/12/Digital-Asset-Allocation-Plan_CryptoTaxGirl.pdf
Koinly.io: https://koinly.io/ (Note: There are other tax preparation services available, do your own research)
Disclaimer: I am not a tax professional and this information is not tax advice. Consult with a qualified tax advisor for personalized guidance.
