Crypto Accounting Methods: FIFO, LIFO, HIFO & More
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The IRS allows specific identification accounting for crypto. In this method, you keep track of every item of inventory—in this case, every tax lot. Although specific ID requires more documentation than other methods, blockchain data and crypto tax software make it possible and many traders choose to use it as it can reduce capital gains.
Specific ID variations such as FIFO, LIFO, HIFO and TokenTax's proprietary Minimization determine how acquisitions and sales are matched up when calculating your cost basis and gains or losses.
The IRS allows taxpayers to choose which accounting method to use each year. This means that you could change methods between years; it does not mean you can use multiple methods in the same tax year. Your accounting method must be consistent throughout each year's return.
How FIFO, LIFO, HIFO, and Minimization work
First in, first out (FIFO): Assets acquired first are sold first.
Last in, first out (LIFO): Assets acquired last are sold first.
Highest in, first out (HIFO): Highest price assets are sold first
Minimization: TokenTax's own tax-rate adjusted HIFO algorithm
Below, we'll go over how FIFO, LIFO, and HIFO would produce tax liability for the following simple scenario.
Diana buys 10 LTC when it is trading for $40 ($400).
She buys another 10 LTC when it is trading for $150 ($1,500).
She buys another 10 LTC when it is trading for $80 ($800).
She sells 10 LTC when it it is trading for $300 ($3,000).
With FIFO accounting, Diana would set her cost basis for the sale as $400 (10 x $40) because she acquired assets at that price first.
$3,000 - $400 = $2,600 of capital gains
With LIFO accounting, Diana would set her cost basis for the sale as $800 (10 X $80) because she acquired assets at that price last.
$3,000 - $800 = $2,200 of capital gains
With HIFO accounting, Diana would set her cost basis for the sale as $1,500 (10 X $150) because that was the highest cost per unit she paid for that asset.
$3,000 - $1,500 = $1,500 of capital gains
What about the average cost method?
In Canada, the United Kingdom, and in certain other countries, tax payers must use average cost accounting. In this method, cost basis is set as the average price paid for all tokens of a specific cryptocurrency. That cost basis is used for every single sale of that crypto across all assets.
Note that this method is not used in the United States and in any other country that requires methods like FIFO, LIFO, etc.
Which method is best for reducing tax liability?
In order to reduce your taxes, HIFO (highest in, first out) accounting sells the asset with the highest cost basis first, as you can see in the example above.
In TokenTax’s crypto tax software, we’ve improved upon the HIFO method with our proprietary Minimization accounting method, which makes adjustments based on an individual’s tax rate to minimize crypto taxes as much as possible.
Which accounting method should I use?
In the end, the accounting method you choose will not change your total capital gains. It only changes the timing of your capital gains. Minimization can help prioritize long-term gains over short-term gains.
This way, your crypto will be taxed at a lower rate whenever possible.
Or, for example, you may expect to be in a higher tax bracket next tax year, so you will want to use FIFO to claim as much gains as possible this year while you are in a lower tax bracket.
Get more information in our crypto tax guide.
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Last reviewed by Zac McClure,MBA on September 18, 2023 · Sources