Taxation Methods

Different Methods of Taxation

Different Methods of Calculating Cost Basis

Definition

FIFO - First In, First Out

As the name suggests, this method of calculation considers the first cryptocurrency coin that is purchased as the first unit that is sold.


Using the FIFO method, capital gains for 10 units sold will be calculated based on the prices of the first 10 available units that were purchased

In other words, the coins are sold in the same order as they were purchased, hence, “First in, First out.”

LIFO - Last In, First Out

In complete contrast, the LIFO method considers the last units purchased as the first ones sold. So, capital gains on 5 BTC sold will be calculated based on the 5 BTC available that were most recently purchased.

HIFO - Highest in, First Out

This method considers the coins with the highest purchase price as the ones sold first.

The HIFO method generally is ideal for minimizing taxes as it is designed to calculate the largest capital losses as well as the lowest capital gains, providing the taxpayer the best case in both scenarios.

However, if some coins are held for more than one year and others for less than or equal to one year, different tax rates apply. So using a different method or specifically identifying coins may be beneficial.

 

FAQ’s:

  • Can I use HIFO for crypto?
    • Yes. IRS guidance states that crypto investors can use HIFO, provided that they keep detailed records and can identify specific units of cryptocurrency.
  • Can I change calculation methods from year to year? 
    • Yes. IRS guidelines allow investors to change calculation methods from year to year. However, you have to keep accurate records to make sure you are properly accounting for each sale.
  • What accounting method should I use for my crypto?
    • While American crypto investors can use FIFO, LIFO, and HIFO, many choose to use FIFO because it is the most conservative option.



DISCLAIMER: This post is for informational purposes only and should not be interpreted or relied upon as a substitute for the advice of financial, legal, or tax professionals. This content also only addresses U.S. federal income tax consequences for U.S. citizens and residents and does not address tax consequences that may be relevant to a particular person subject to special rules, such as dealers or traders. You should consult with your own financial, legal, or tax professionals to report and file your crypto taxes or make decisions on your particular circumstances. The laws, regulations, or interpretation of the existing laws could change, which may adversely affect either prospectively or retroactively. The content of this post is subject to changes.