FIFO, LIFO, minimization, and average cost explained
TokenTax offers four accounting methods to calculate your tax liability:
First in, first out (FIFO). Assets acquired first are sold first.
Last in, first out (LIFO). Assets acquired last are sold first.
TokenTax minimization. Our algorithm will look at all available purchases and sell the one that minimizes taxes every time. It also factors into account the difference in tax rates between short-term and long-term gains.
Average cost. Average cost takes into account the average cost basis across all your assets. This isn’t used for U.S. crypto tax. but it is required in the U.K. and Canada.
The accounting method you choose will change your tax liability. Our minimization algorithm chooses the accounting method that lowers your tax liability the most.
How does minimization work?
Imagine you bought 3 BTC:
1 in July 2017 for $2k.
1 in June 2018 for $7k.
1 in December 2018 for $5k.
Your taxable gain will be calculated by the proceeds minus the cost basis (the amount the asset was bought for). Let’s see FIFO and LIFO in action first:
You sell 1 BTC in December 2018 for $4k.
FIFO: $4k - $2k (July 2017 cost basis) = $2k gain (note that this will be taxed as a long term gain!)
LIFO: $4k - $5k (November 2018 cost basis) = $1k loss
Now let’s see this BTC sale but with tax minimization, where our algorithm chooses the best cost basis for reducing tax liability.
Minimization: $4k - $7k (June) = $3k loss
A higher loss on your taxes may let you reduce capital gains or deduct from your tax return. Keep in mind that there are times when you may want to trigger a gain to get it out of the way — maybe you expect to move to a higher tax bracket, or you expect BTC to hit a new all time high in the near future. There are also cases where FIFO will make more trades long term, thus taxed at a lower rate.
As is the case with many facets of crypto taxation, the IRS has not outlined strict policy for accounting methods to use specifically with crypto currency, as crypto is still classified as property. Internationally, it varies — the UK and Canada, for example, only allows for average cost accounting.
TokenTax does the hard work so you don’t have to.
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