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The IRS has started sending out letters to cryptocurrency traders warning them of the tax implications of crypto. The letter, known as IRS Letter 6174-A for cryptocurrency, alerts traders that the IRS is aware they may have misreported their cryptocurrency transactions on their tax return. This comes on the heels of the announcement that the IRS plans to release further cryptocurrency tax guidelines, according to Commissioner Charles P. Rettig.
According to Rettig, the IRS is working on providing clarity for “acceptable methods for calculating cost basis, acceptable methods of cost basis assignment, and the tax treatment of forks.” This article addresses the most important things to watch out for in the new guidance and why they matter.
1. Acceptable Methods for Calculating Cost Basis
The 2014 guidance states that the fair market value for cryptocurrency is determined by converting into US dollars “at the exchange rate, in a reasonable manner that is consistently applied.” However, this leaves considerable questions, as cryptocurrency can widely vary in price and sometimes not have a correlated USD price at all.
There are several different methods for cost basis calculation with other forms of property like trading stocks. The initial guidance does not specifically declare whether or not accounting methods like first-in, first-out (FIFO), average cost basis (ACB) or last-in, first-out (LIFO) would be acceptable for cryptocurrencies.
This gray area has left cryptocurrency investors questioning whether or not their chosen cost basis calculation method could be challenged by the IRS. Software and crypto tax calculators specifically built for crypto taxes often offer users multiple cost basis calculation options, and investors today are using a variety of methods.
Clarification around cost basis calculation is important as different methods can lead to different sizes of gains and losses.