This episode exposes the hidden tax complexities of crypto ETFs and the impending IRS Form 1099-DA, revealing critical compliance challenges for digital asset investors.
Crypto as Property: Foundations of Digital Asset Taxation
- The IRS treats cryptocurrencies and NFTs as property, not currency. This classification dictates how all digital asset transactions are taxed.
- Taxable events include cashing out crypto, exchanging one crypto for another, or earning crypto through staking and rewards.
- Crypto taxation largely mirrors stock taxation, with specific exceptions.
- “Cryptocurrencies... are treated as property according to IRS rules.” – Shehan Chandrasekera
- Shehan Chandrasekera, Head of Strategy at CoinTracker, explains the foundational IRS stance.
Strategic Tax Loss Harvesting & The Wash Sale Loophole
- Year-end tax strategies offer opportunities to reduce capital gains liabilities. Tax loss harvesting involves selling assets below their cost basis (original purchase price) to realize losses.
- Realized losses can offset capital gains from both crypto and stock transactions.
- If capital losses exceed capital gains, up to $3,000 can offset ordinary income annually, with remaining losses carrying forward indefinitely.
- The IRS wash sale rule, which prohibits deducting losses if a security is repurchased within 30 days, does not apply to crypto because crypto is classified as property, not a security.
- Despite the wash sale rule's inapplicability, Shehan Chandrasekera cautions against immediate repurchases, advising a "reasonable period" (e.g., a few days) to establish economic substance for the transaction, preventing IRS scrutiny.
- “For crypto... the wash sale rule is not applicable to crypto transaction.” – Shehan Chandrasekera
- Shehan Chandrasekera details these strategies, while Steve Erlich, Executive Editor at Unchained, probes the nuances of the wash sale rule.
Stablecoins, Airdrops, and the Hidden ETF Tax Burden
- The evolving crypto landscape introduces unique tax considerations for stablecoins and exchange-traded products (ETPs).
- Stablecoins, despite their dollar peg, are treated as property. Any minor fluctuation resulting in a gain or loss requires reporting on Form 8949, even for small everyday transactions.
- No de minimis exemption (a threshold below which transactions are exempt from reporting) currently exists for crypto, meaning every stablecoin transaction is technically reportable.
- Crypto ETPs (Exchange-Traded Products), such as ETFs, carry a hidden tax liability. Beyond reporting gains/losses from selling ETP shares, investors must also calculate their allocable share of digital assets disposed by the fund to cover its expenses. This "second step" is not captured on standard 1099-B forms from brokers.
- “If you traded like ETPs... there's a second step that you need to do in addition to relying on the 1099B that you're getting from the broker.” – Shehan Chandrasekera
- Shehan Chandrasekera clarifies the reporting requirements for stablecoins and highlights the overlooked tax implications of ETPs.
The 2025/2026 1099-DA Rollout: Partial Truths and Reconciliation Headaches
- The Infrastructure Bill mandates a new IRS Form 1099-DA for digital asset brokers, starting with the 2025 tax year (filed in 2026). This rollout presents significant challenges.
- For the 2025 tax year, the 1099-DA will report only proceeds from sales, omitting the cost basis. This will lead to overstated gains, requiring investors to manually track and input their cost basis.
- For the 2026 tax year, exchanges will report both proceeds and cost basis, but only for transactions where the asset was acquired and sold on the same exchange. Assets transferred from self-custody wallets or other exchanges will still lack cost basis reporting.
- Mismatches will arise between exchange-reported data and individual accounting methods (e.g., HIFO - Highest-In, First-Out; FIFO - First-In, First-Out; LIFO - Last-In, First-Out), necessitating complex reconciliation.
- Seven transaction types remain unreported on the 1099-DA: stablecoin transactions under $10,000, NFT transactions under $600, wrapping, lending, non-US exchange activity, and all DeFi (Decentralized Finance) transactions.
- “DA is going to show just a very partial truth of like, you know, what you did in a given year.” – Shehan Chandrasekera
- Shehan Chandrasekera outlines the phased implementation and inherent limitations of the 1099-DA.
Immediate Action: Setting Accounting Methods and Harvesting Losses
- Proactive measures are essential for navigating current and future crypto tax obligations.
- Investors should perform tax loss harvesting before year-end to reduce their 2023 tax bill.
- It is critical to set a preferred accounting method (HIFO, FIFO, LIFO) on centralized exchanges now. Exchanges will default to FIFO starting January 1, 2026, if no method is specified, potentially leading to suboptimal tax outcomes.
- “If you don't set an accounting method... they're going to default you to first in first out which may not be ideal.” – Shehan Chandrasekera
- Shehan Chandrasekera advises immediate action to optimize tax positions and prepare for new reporting standards.
Investor & Researcher Alpha
- Capital Movement: The impending 1099-DA complexities will drive significant capital towards specialized crypto tax software and professional advisory services, as manual reconciliation becomes untenable for active traders.
- New Bottleneck: The primary compliance bottleneck shifts from simply tracking transactions to accurately reconciling fragmented data across exchanges, self-custody, and DeFi, demanding robust, integrated accounting solutions.
- Research Direction: Research into automated, verifiable on-chain accounting and reporting protocols for DeFi and self-custody gains urgency, aiming to bridge the gaps left by centralized exchange reporting.
Strategic Conclusion
- Navigating fragmented and evolving crypto tax regulations demands proactive engagement. The industry requires integrated, transparent tax reporting solutions to support mainstream digital asset adoption.
