The IRS has drastically changed how crypto cost basis is calculated for 2025 and forward. Since basis is now calculated on a wallet-by-wallet approach, taxpayers will need to be very cognizant of how and where they dispose of their crypto to avoid phantom capital gains.
Wallet-By-Wallet Accounting Required
In our previous article, we talked about the new rules for cost basis and the end of the “universal wallet” approach and the IRS’s rationale for making the change. In this article, we want to give some examples as to how this will affect taxpayers in practice and outline steps they would want to take to strategize accordingly.
Let’s say you own 8 BTC and choose to sell one. How were your taxes treated previously and how will they look under the new rules? Here’s your portfolio:
Exchange | Cost Basis | Date Purchased |
Coinbase | $20,000 | 01/01/2020 |
Binance | $40,000 | 01/01/2023 |
Kraken | $60,000 | 04/01/2021 |
Crypto.com | $95,000 | 12/10/2024 |
Coinbase | $50,000 | 12/01/2021 |
KuCoin | $100,000 | 12/01/2024 |
Kraken | $10,000 | 01/01/2018 |
Coinbase | $30,000 | 10/01/2023 |
Old Rules: Universal Wallet Approach
Under the universal wallet approach, your entire portfolio was treated as one wallet, regardless of where it was held.
If you were to sell one Bitcoin from your Coinbase account for $105,000, here’s how it would look with the different methods:
- FIFO: $95,000 gain ($10,000 cost basis from Kraken BTC)
- HIFO: $5,000 gain ($100,000 cost basis from KuCoin BTC)
- LIFO: $10,000 gain ($95,000 cost basis from Crypto.com BTC)
Again, this is pretty simple and what most taxpayers have been used to. Where the crypto was held and where you sold it from did not matter because it was all treated as one giant wallet for tax purposes.
New Rules: Wallet-By-Wallet Approach
The new rules did away with this method and require that each wallet and its corresponding cost basis be calculated separately. If you sell that same 1 BTC from Coinbase for $105,000 now, here is how it would look:
- FIFO: $85,000 gain ($20,000 cost basis from 01/01/2020 Coinbase BTC)
- HIFO: $55,000 gain ($50,000 cost basis from 12/01/2021 Coinbase BTC)
- LIFO: $75,000 gain ($30,000 cost basis from 10/01/2023 Coinbase BTC)
That is a pretty massive difference in the total gain (and the income tax associated with it). The HIFO gain increased over 10 times (from $5,000 to $55,000) compared to the old approach. For our purposes now, nothing outside of the exchange you are selling the asset from exists for cost basis calculations.
In some situations this may help you (the FIFO gain in our example was $10,000 less than under the old rules), but for HIFO these new rules are more likely to burn you. This means that appropriate planning is going to be extremely important.
Notify Exchanges of Your Election
The first thing to do is to make sure you notify the exchange of the accounting method you want to use. Otherwise, they will all default to FIFO. As shown in the example above and as we’ve noted many times in the past, this is often a poor choice for most crypto investors.
The deadline to notify the exchanges is 01/01/2025. If you are reading this after the deadline, you should still be able to change your election, but previous activity will still have defaulted to FIFO. Coinbase gives an example of this:
“You may change your tax lot relief method more than once. If you do, the prior method will be applied to all digital asset transactions up to the effective date and time of the method change. For instance, assume you first make a tax lot relief method change to HIFO on February 28, 2025 at 5:00 PM ET and then change your method to LIFO on June 30, 2025 at 5:00 PM ET.
- Transaction activity between January 1, 2025 and February 28, 2025, 5:00 PM ET will reflect the FIFO method.
- Transaction activity between February 28, 2025, 5:01 PM and June 30, 2025, 5:00 PM ET will reflect the HIFO method.
- Transaction activity between June 30, 2025, 5:01 PM ET and December 31, 2025 will reflect the LIFO method.”
Tax Strategies for New Rules
The new method will also require careful planning for where you are selling your assets. In the past it did not matter, now it obviously does.
In our example above, the taxpayer would have been much better served selling the BTC from KuCoin rather than selling it on Coinbase. This would have reduced their gain by $50,000 under HIFO.
Or – if selling on KuCoin was untenable for one reason or another – they should have transferred the Bitcoin itself from KuCoin to Coinbase prior to selling. At that point the $100,000 basis BTC would be held by Coinbase and allowed to be used for the cost basis calculation. Under HIFO it would be what was selected – even under the new rules.
Because of situations like that, this new rule is also likely to cause more consolidation of crypto assets/have investors hold more of their assets in one place rather than having them spread around. This is unfortunate for a few reasons:
- The core idea behind crypto is decentralization
- It increases investor risk if an exchange fails or goes bankrupt, which we’ve seen happen all too often in the past. FTX, Voyager, Celsius, and other exchanges all failed within a few months of each other. Investors who had some assets on those exchanges obviously suffered some loss. Investors who had everything on those exchanges lost everything
Given the inherent risk of holding your crypto assets on centralized exchanges – let alone on a single centralized exchange – investors are going to need to avoid the temptation of holding everything on one CEX for convenience. They are still going to want to utilize cold storage and other risk mitigation strategies.
But when it comes to the disposition of an asset, they are going to need to be very cognizant of where they do that and plan accordingly.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
