What Is LIFO, FIFO, and HIFO? Crypto Accounting Methods

Understanding how crypto is taxed in the US is key to grasping the significance of various crypto accounting methods. When you dispose of crypto, you typically incur a capital gain or loss based on the price change since you acquired it.

If you profit, you're subject to capital gains tax, while a loss can offset other gains. To calculate your gain or loss, you subtract your acquisition cost (crypto cost basis) from the sale proceeds. Crypto tax software like ours at TokenTax makes this process simple.

When dealing with cryptocurrency taxes, choosing the right accounting method is crucial, especially if you've bought your cryptocurrency at different prices. Your chosen method determines the order in which you sell your cryptocurrency, significantly impacting your tax bill. While the First In, First Out (FIFO) method is commonly used, other methods like Highest In, First Out (HIFO) can save you money on taxes.

The IRS allows taxpayers to choose their accounting method each year. Your accounting method must be consistent throughout each year's return. When in doubt, consult with one of our crypto tax professionals, who can assist you with all your crypto tax questions.

The IRS typically mandates the First In, First Out (FIFO) accounting method unless you can accurately track the tax lots of your crypto transactions. With TokenTax, you can track each tax lot, enabling you to use methods beyond FIFO for your crypto accounting.

Crypto taxes in the US hinge on capital gains or losses incurred upon disposal, where the price variation from acquisition dictates the tax implications. FIFO, LIFO, and HIFO are three possible accounting methods to determine crypto capital gains.

The IRS has provided guidance on accounting methods for cryptocurrency transactions. Crypto owners can choose which cryptocurrency units to sell, exchange, or dispose of, as long as they can identify the specific units and substantiate their basis through unique digital identifiers or transaction records showing acquisition and disposal details.

If specific units are not identified, the IRS deems the units to be sold in chronological order, following FIFO basis, starting with the earliest acquired units.

Basics about FIFO, LIFO, and HIFO

• 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.

Crypto accounting methods examples

Below, we'll review how FIFO, LIFO, and HIFO would produce tax liability for the following simple, hypothetical scenario.

• Diana buys 10 LTC in January when it trades for $40 ($400).

• She buys another 10 LTC in April when it is trading for $150 ($1,500).

• She buys another 10 LTC in September when it is trading for $80 ($800).

• She sells 10 LTC in December when it is trading for $300 ($3,000).

What is FIFO, and how does it work?

FIFO, or first-in-first-out, methodically sells the earliest acquired cryptocurrency first, potentially reducing tax burdens, especially amid falling market prices.

• With FIFO accounting, Diana would set her cost basis for the sale as $400 (10 x $40) because she first acquired assets at that price.

• $3,000 - $400 = $2,600 of short-term capital gains.

What is LIFO, and how does it work?

LIFO, or last-in-first-out, prioritizes selling the most recently acquired assets, which might yield advantages during a bull run.

• 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 short-term capital gains.

What is HIFO, and how does it work?

HIFO, or highest-in-first-out, targets selling assets with the highest cost basis initially. This often results in significant tax savings and larger capital losses, which can be offset against other income.

• 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 short-term capital gains.

What is the average cost method in crypto accounting?

Taxpayers must use average cost accounting in Canada, the UK, and other countries. 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 US or any other country that requires methods like FIFO, LIFO, etc.

When it comes to navigating the complexities of crypto tax reporting, TokenTax has you covered. Our platform offers a range of features to streamline the process and ensure accuracy.

Data Import: Sync your data seamlessly from all your wallets and accounts, reducing the need for manual data entry and ensuring accuracy.

Tax Reports: Easily generate detailed tax reports, including FIFO, LIFO, Minimization, and average cost tax liability calculations, tax loss harvesting dashboard, mining and staking income reports, Ethereum gas fee tax reports, and custom enterprise reports.

Reconciliation: For investors with more complex accounting needs, our team of crypto-savvy tax professionals provides advanced reconciliation services, handling everything from missing cost basis to high transaction volume and cross-chain transactions.

The IRS generally mandates the use of the First In, First Out (FIFO) method unless you can accurately track the tax lots of your crypto transactions. With TokenTax, you can track each tax lot, enabling you to use methods beyond FIFO for your crypto accounting.

This is a major advantage over merely printing transaction records from an exchange, which limits you to the FIFO method. Our platform ensures you can meet IRS requirements while optimizing your tax strategy.

Here are answers to frequently asked questions about crypto accounting methods.

Which method is best to reduce crypto taxes?

In order to reduce your crypto taxes, HIFO (highest in, first out) accounting sells the asset with the highest cost basis first, as you can see in the example above.

With our crypto tax software, we’ve improved 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 crypto accounting method should I use?

Ultimately, your chosen accounting method 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.

In another case, you may expect to be in a higher tax bracket next tax year, so you will want to use FIFO to claim as many gains as possible this year while you are in a lower tax bracket.