Home » FIFO vs. HIFO Crypto Accounting: Which Method is Best for Your Company?

FIFO vs. HIFO Crypto Accounting: Which Method is Best for Your Company?

In the US, a company's crypto taxes depend on whether a profit or loss was made when selling or trading cryptocurrency, based on the price change since acquisition. Using Cryptoworth, finance professionals can calculate profits with various methods: FIFO, LIFO, HIFO.

Choosing the Right Crypto Accounting Method in the US: Is it FIFO or HIFO?

Table of Contents

1. Understanding Crypto Taxation
2. What is FIFO? And the Advantages of FIFO?
3. What is HIFO? Advantages of the HIFO Method?
4. Comparing FIFO and HIFO in Crypto
5. When is HIFO Used? When is LIFO Used?
6. HIFO Method Problems and Solutions
7. Choosing the Right Method
8. Crypto Accounting Methods FAQs

Use this structured table of contents to navigate the comprehensive article on FIFO vs. HIFO crypto accounting, tailored for finance professionals handling corporate tax and accounting.

Understanding Crypto Taxation

When companies sell, exchange, or spend cryptocurrency, a taxable event is triggered. The IRS treatment for cryptocurrency is detailed in IRS Notice 2014-21. Taxable gains or losses are calculated based on the difference between the purchase price (cost basis) and the sale price. Choosing the right accounting method, such as understanding HIFO vs FIFO, can significantly affect the company’s tax obligations.

The IRS typically mandates the First In, First Out (FIFO) accounting method unless you can accurately track the tax lots of your crypto transactions

In the US, gains are taxed at capital gains rates of 0%, 15%, or 20%, or at ordinary income tax rates of 10% – 37%. You can also deduct capital losses, but there are limits on how much you can write off.

The IRS has provided guidance on accounting methods for cryptocurrency transactions. Digital asset 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 IDs or transaction records showing acquisition and disposition.

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

Accounting Methods Explained: LIFO, FIFO & 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

Watch our webinar on the 5 Essential Insights and Key Strategies for Tax Compliance and Crypto Accounting, by Patrick Camuso-CPA, or read the summary here.

What is FIFO?

FIFO, or First-In-First-Out, is a common accounting method where the first assets purchased are the first ones to be sold. This method is straightforward and often required by default unless specific identification of units is possible.

Advantages of FIFO:

1. Simplicity: FIFO is easy to apply and is the default method for many investors.

2. Long-term Gains: FIFO can help you take advantage of long-term capital gains tax rates if the cryptocurrency has been held for more than a year.

3. Falling Prices: If the market is declining, using FIFO might result in a higher cost basis, thereby reducing taxable gains.

Example for FIFO:

  1. A company buys 10 BTC at $12,000 in February, 
  2. In April, the company buys another 10 BTC at $18,000
  3. In August, they buy another 10 BTC at $22,000.
  4. The company sells 10 BTC at $30,000 in November.

Using FIFO, the cost basis is $12,000 per BTC, resulting in a taxable gain of $18,000 per BTC.

What is HIFO?

HIFO, or Highest-In-First-Out, prioritizes selling the highest-cost basis assets first. This method is advantageous for minimizing taxable gains, especially in volatile markets where prices fluctuate significantly, making it essential to understand HIFO vs FIFO crypto accounting methods.

Advantages of the HIFO Method:

1. Tax Minimization: The HIFO cost basis method typically results in the lowest taxable gains and the highest potential tax savings.

2. Flexibility: HIFO can adapt to market conditions, making it a strategic choice during periods of high volatility.

Example for HIFO:

  1. A company buys 10 BTC at $12,000 in February, 
  2. In April, the company buys another 10 BTC at $18,000
  3. In August, it buys another 10 BTC at $22,000.
  4. The company sells 10 BTC at $30,000 in November.

Using HIFO, the cost basis is $22,000 per BTC, resulting in a taxable gain of $8,000 per BTC.

In Canada, the United Kingdom, and other countries, companies must use the average cost method or WAC, setting the cost basis as the average price paid for all tokens of a specific cryptocurrency.

Comparing FIFO and HIFO

Table of FiFO vs HiFO for Crypto Accounting.
Feature FIFO HIFO 
Tax ImpactHigher taxable gains in a rising market, but beneficial in a falling market.Lower taxable gains, maximizing tax savings
Record-KeepingSimpler record-keeping requirementsRequires detailed records of each transaction
ComplianceGenerally accepted and easier to comply with IRS regulationsAllowed by IRS if accurate records are maintained
Market Condition SuitabilityBetter in declining marketsBetter in volatile or rising markets

Usually it’s a discussion between FIFO and LIFO. ‘HIFO’ is very strange to use with Bitcoin because Bitcoin is fungible and the value uniform across all Bitcoins.

from Reddit user bit-usher.

NOTE: The IRS permits the use of the HIFO cost basis for accounting, provided that you keep comprehensive records, including:

- The date and time each unit was bought
- The fair market value of each unit at the time of purchase
- The date and time each unit was sold, exchanged, or otherwise disposed of
- The fair market value at the time of sale, exchange, or disposal, along with the amount of money or value of property received for each unit

When comparing HIFO vs FIFO crypto accounting methods, it’s clear that each has unique advantages and impacts on your tax obligations.

When is HIFO Used?

The HIFO method is often used when the goal is to minimize tax liabilities, particularly in volatile markets where cryptocurrency prices vary significantly. This method is advantageous for active traders who frequently buy and sell their assets, highlighting the importance of understanding crypto HIFO vs FIFO methodologies.

When is LIFO Used?

LIFO, or Last-In-First-Out, is used when you want to sell your most recently acquired assets first. This method can be beneficial in a rising market, where the last purchased assets have the highest cost basis, potentially lowering your taxable gains. For companies considering different accounting methods, comparing HIFO vs FIFO and understanding crypto tax HIFO or HIFO can provide significant insights.

HIFO Method Problems and Solutions

ProblemSolution
ComplexityThe HIFO method requires detailed record-keeping, which can be complex and time-consuming.Use Crypto specialized software.
These can automate the record-keeping process, ensuring compliance with IRS regulations.
Compliance
Strict IRS requirements must be met, including maintaining comprehensive transaction records
Consult a Tax Professional.
A tax advisor can help navigate the complexities of the HIFO method and ensure that all records are accurately maintained.

As an accounting professional, you should use robust data-reliable crypto accounting software to automate and stay compliant with these requirements to avoid any gaps in reporting.

Choosing the Right Method

The choice between FIFO and HIFO depends on the specific financial situation, investment strategy, and market conditions of the company, emphasizing the need to evaluate crypto HIFO vs FIFO methods. FIFO is simpler and may be suitable for less active trading or long-term holdings. HIFO, on the other hand, is ideal for companies looking to minimize tax liabilities through active trading.

Tips:

1. Consult a Tax Professional or CPA: Always consult with a certified tax advisor to understand the implications for your company’s unique situation.

2. Use Crypto Accounting Software: Tools like Cryptoworth can automate the process, ensuring compliance and accuracy.

3. Review Annually: Companies can change their accounting method each year, allowing adaptation to changing market conditions and financial goals.

Conclusion

Choosing the right crypto accounting method can save companies significant amounts in taxes. While FIFO offers simplicity and long-term benefits, HIFO provides powerful tax minimization potential. Comparing HIFO vs FIFO is essential for optimizing your crypto tax strategy.

HIFO generally results in the least amount of taxes and is often preferred by many crypto taxpayers. However, FIFO or LIFO can be useful if you’re anticipating a lower tax year and want to cash out your positions at a lower tax rate. Switching methods year-to-year is possible using Specific ID, as long as you can specifically identify the units you are selling.

Additionally, the IRS recently published a new draft requiring any crypto transaction to be recorded on Form 1099-DA. This emphasizes the need for precise record-keeping. Leveraging crypto accounting software like Cryptoworth can help manage these requirements, offering flexibility and precision in financial operations. Always consult with a certified tax advisor to ensure compliance and optimize your tax outcomes.

Crypto accounting methods FAQs

The best cost-basis method depends on your company’s strategy, but HIFO often minimizes taxable gains, while FIFO is simpler and beneficial in declining markets.

Your company should choose the method that aligns with its financial strategy and market conditions, with HIFO being ideal for active trading and tax minimization.

HIFO typically lowers your tax bill the most by selling the highest-cost basis assets first, resulting in the lowest taxable gains.

Yes, HIFO can be used for crypto if you maintain accurate records of each transaction as required by the IRS.

HIFO is often better for minimizing taxes on crypto gains, while FIFO is simpler and may be better in certain market conditions.

Coinbase allows users to select their accounting method through their account settings, offering options for FIFO, HIFO, or LIFO.

Author

Cryptoworth

Cryptoworth, a leading crypto accounting software that helps web3 accountants speed up month-end closing.

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