Thanks for the various replies!

It seems that, in the case of KYC Bitcoin, keeping good records of the UTXOs sent to others or received from others would be important. Say I buy a used car off Craigslist. If I keep a careful record of the UTXOs involved in the purchase, and possibly also "KYC" on the person I bought it from, then I could always provide that as "proof" if the Bitcoin were ever to be used for something illegal and traced back to me. Hopefully it's an unlikely scenario, but at least keeping records would make it easier to put up a defense if there were to be an issue down the road.

I think it's starting to make more sense to me now. I appreciate the insights.