When accounting for sales, FIFO, LIFO, HIFO and average weighted cost are accounting methodologies. This post is intended for US taxpayers and is specifically for short term gains. The tax burden on long term gains is typically much more beneficial.
FIFO= First in first out.
This type of accounting assumes you are selling your oldest asset first.
Ex: I bought 1 Bitcoin in June, 2 in November and 1 in December. These are all currently less than a year old and all would be considered short term gains if I sell them before I've had them for a year
If I sell 1 Bitcoin this last January, with FIFO, it assumes I’m selling that one that I bought in June.
Since this would still be taxed as short term gains, depending on that June price, FIFO may cost me a lot more in taxes than other methodologies .
Ex: June purchase was 15,000 each, November was 18,000 each and December was 35,000 each.
If I sell my “June” coin in January for 40,000, I have short term gains of $25,000 that will be taxed.
HIFO= Highest in first out
This type of accounting assumes you are selling your most expensive acquisition first. When we consider the effect of short term gains, this may be a very beneficial methodology
If I do a little extra accounting, I can say that I sold the “December” coin in January, and I have short term gains of $5,000 that will be taxed.
This can potentially save you a lot in taxes as you wait for other those purchases to become long term gains.
Some accountants have disagreed that this approach would work. The Gordon Law Group at https://gordonlawltd.com/ has stated in a Reddit AMA that the IRS's default is FIFO, and using LIFO may trigger audits and the IRS may disagree with the use of that accounting practice for cryptocurrencies.
However, based on Shehan Chandrasekera's article in Forbes, using LIFO is acceptable.
Although there is no direct guidance on this issue, changing the tax lot ID method from year to year would be accomplished by using Specific ID. For example, you could go from FIFO to HIFO as long as you can specifically identify the units you are selling. Moreover, in the tax forms, you are not required to report which method you are using. You will only have to provide that info and substantiate your calculations if your tax return gets examined.
So, we have two tax professionals with differing opinions. Which is not surprising given the IRS's tepid grasp on cryptocurrencies.
How do you identify the units you are selling?
With a little work, this is relatively easy.
- Date and time of acquirement
- cost basis and fair market value of your acquisition when it was acquired
- date and time of when it was sold, disposed of, or exchanged
- the fair market value of each when sold, exchanged, or disposed of, and the amount of money received for each unit.
As always, check with a tax professional, but these methodologies can substantially change your tax burden and are absolutely worth talking to your tax professional about.
Do you have past experience using HIFO or LIFO? Comment below. I'd love to hear your experience.