If you or your family members hold crypto assets, there’s a critical change coming up that you may want to act on by December 31, 2024. Let’s break down what’s changing and what you need to do, if you want to qualify for safe harbor protections related to the basis of your crypto assets. Basis is relevant because when you sell your crypto assets, you will pay capital gains tax on the difference between your “basis” or the cost at which you purchased, and the sale price, or the price at which you sell your assets.
In the past, tracking basis for purposes of reporting gain on the sale of crypto assets was able to be combined across all tokens and all wallets. As a result, whether you bought or sold crypto in any one wallet or exchange, you could use first-in/first-out (FIFO), last-in/first-out (LIFO), Highest Cost First Out (HCFO) or other capital gains reporting methods across all of your crypto assets. Starting in the 2025 tax year, that will no longer be the case, and you must track each wallet’s cost basis separately.
Example of the Impact of New Crypto Basis Rules
Here’s a practical example of how this change impacts you:
Let’s say you bought 2 Bitcoin on Kraken at $50,000 each, and also purchased 2 Bitcoin on Coinbase at $5,000 each, and have held all of it until now (smart thinking). Under 2024 and prior basis rules, if you sold your Bitcoin on Coinbase, you could choose to apply the higher cost basis from your Kraken purchase to minimize your capital gains – a strategy known as Highest Cost First Out (HCFO). However, starting in 2025, you wouldn’t be able to use HCFO or FIFO across wallets. Each exchange account and crypto wallet address will be treated as a separate account with its own isolated cost basis.
The IRS is providing a one-time “safe harbor” until December 31, 2024, allowing investors to choose how to allocate their cost basis across accounts. Missing this deadline could significantly impact your ability to manage your crypto tax strategy effectively.
To read Rev Proc 2024-28, do so here: https://www.irs.gov/pub/irs-drop/rp-24-28.pdf
4 Options For How to Handle the Change in the Basis Rules
This is not financial or investment advice, and you may want to seek individual advice. These are the 4 actions we’ve identified you may want to consider:
- Consolidate Accounts by Dec. 31, 2024:
Merge all digital assets into one account to simplify safe-harbor compliance. Allocate unused basis globally or per unit before the due date, as per the safe harbor options provided below. After meeting the safe harbor, assets can be redistributed to reduce concentration risk, maintaining assets on a wallet-by-wallet basis. - Use Crypto Tax Software:
Use software that supports wallet-by-wallet basis allocation and avoids double-counting. Evaluate existing tools and transition to suitable software before Jan. 1, 2025, if necessary. The challenge here is going to be that you may not have documented basis information to feed into your crypto tax software. - Sell Assets Before 2025:
Liquidate digital assets by Jan. 1, 2025, apply all unused basis, pay your taxes, and start over. Consider tax implications like gains, losses, and wash-sale rules if planning to repurchase. - Retain Holdings and Allocate Unused Basis:
Keep digital assets as-is and use Rev. Proc. 2024-28 to allocate unused basis for safe-harbor compliance.
IRS guidance provides two methods for allocating your cost basis:
Specific Unit Allocation: This method allows you to choose which cost basis goes to which wallet or account. Think of it like organizing your physical assets – you get to decide which items go in which boxes. You must complete this allocation before your first crypto transaction in 2025 or your tax return due date, whichever comes first.
Global Allocation: This approach uses a predetermined rule to allocate your cost basis across accounts. For example, you might allocate the highest cost basis units first, followed by the lowest. You must document your chosen rule before January 1, 2025, and complete the allocation by your 2025 tax return due date.
According to Laura Walter, at CryptoTaxGirl.com, you can sign and date a digital asset allocation plan document, available on the CryptoTaxGirl website before January 1, 2025. Signing that document will require you to choose a basis allocation method to allocate your basis across crypto assets held before January 1, 2025. Talk to your CPA about which basis allocation method to choose, after your 2024 transactions have been reconciled, and then you can fill in the blank. Laura recommends “When in doubt, apply the Highest Cost Allocated First method to your Digital Asset Allocation Plan.”
Why This Matters for Your Legacy Planning
As your Personal Family Lawyer® Firm, we’re particularly concerned about how these changes affect your estate planning. Here’s why:
- If you pass away without properly allocating your crypto cost basis, your heirs could face significant tax complications and potentially higher tax bills.
- The documentation requirements for crypto assets are becoming more stringent, making it crucial to incorporate them properly into your estate plan.
- Your chosen allocation method could affect the tax efficiency of any crypto assets you plan to leave to your loved ones.
Steps to Take Now
The most important step you can take before year-end is to consolidate all your cryptocurrency of the same type into a single wallet. This allows you to effectively mix the cost basis of your holdings, giving you maximum flexibility when choosing which units to sell in the future. Instead of being restricted to the cost basis of tokens in individual accounts, you’ll have access to your entire range of purchase prices when making sales.
In addition,
- Create an inventory of all your crypto holdings across different wallets and exchanges.
- Gather records of when you purchased your crypto assets and at what price.
- Consider consolidating crypto holdings into fewer wallets to simplify the allocation process.
- Review your estate plan to ensure it properly addresses your crypto assets under these new rules.
- Schedule a meeting with me and your tax advisor to coordinate your approach. My booking link is below.
The crypto landscape continues to evolve, and these new IRS rules are just one example of how digital assets require special consideration in your legacy planning. While the primary deadline is December 31, 2024, the sooner you start preparing, the better positioned you’ll be to protect your digital assets for future generations.
We Can Help Protect Your Digital Legacy
As your Personal Family Lawyer® Firm, we understand the intersection of estate planning and digital assets. We can help ensure your crypto holdings are properly documented and integrated into your life & legacy plan, while coordinating with your tax advisors to address these new IRS requirements. Let us help you protect your digital legacy for your loved ones.
Click here to schedule a complimentary 15-minute consultation to learn more:
This article is a service of Bret Christiansen, a Personal Family Lawyer® Firm. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Life & Legacy PlanningⓇ Session, during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Life & Legacy Planning Session.
The content is sourced from Personal Family Lawyer® for use by Personal Family Lawyer® firms, a source believed to be providing accurate information. This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking legal advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
