How do I account for a sale, exchange, or other disposition of units of virtual currency if I do not specifically identify the units

If you do not specifically identify the units of virtual currency that you are selling, exchanging, or otherwise disposing of, the units are deemed to have been sold, exchanged, or otherwise disposed of in chronological order beginning with the earliest unit of the virtual currency you purchased or acquired. This method is known as the first-in, first-out (FIFO) basis.

Legal Reasoning and Rationale:

1. FIFO Basis Application:
   • According to IRS FAQ Q41, if specific units of virtual currency are not identified, the FIFO method is applied. This means that the units of virtual currency are considered to be sold in the order they were acquired, starting with the earliest acquired units.
2. Specific Identification Option:
   • IRS FAQ Q39 allows taxpayers to choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if they can specifically identify the units involved in the transaction and substantiate their basis in those units. This requires detailed records showing the acquisition and disposition of each unit.
3. Documentation Requirements:
   • To specifically identify units of virtual currency, IRS FAQ Q40 states that taxpayers must document the specific unit’s unique digital identifier (such as a private key, public key, and address) or maintain records showing the transaction information for all units of a specific virtual currency held in a single account, wallet, or address. This documentation must include:
     • The date and time each unit was acquired.
     • The basis and fair market value of each unit at the time it was acquired.
     • The date and time each unit was sold, exchanged, or otherwise disposed of.
     • The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.
4. Default to FIFO:
   • If the specific identification method is not used or cannot be substantiated, the FIFO method automatically applies. This ensures that the earliest acquired units are considered sold first, which can impact the calculation of gains or losses depending on the acquisition and disposition dates and values.

By adhering to these guidelines, taxpayers can ensure compliance with IRS regulations regarding the sale, exchange, or other disposition of virtual currency units.

Sources:
Notice 2014-21
Rev. Rul. 2019-24
Publication 544 (2023)
Cryptocurrency Customer Compliance