Crypto HIFO vs FIFO Accounting Methods

What are the differences between crypto HIFO and FIFO accounting methods? There are different methods by which capital gains on crypto transactions are calculated for tax purposes.

There is the LIFO or Last In First Out method, the FIFO or First In First Out method, and HIFO or Highest In First Out method.

All these come with different characteristics, features and aspects which may differ in the functions but the main purpose of all is the same – to calculate the gains and losses made on crypto transactions.

Choosing the right method will help you in unlocking a simple and easy way to put into practice a straightforward opportunity to save taxes, if at all.

Ideally, FIFO or First In First Out accounting method is typically considered to be the most conservative method.

This is because in the crypto sphere the prices of the coins are usually rising continuously and therefore, this method, which presumes that the initial purchase price has the lowest cost basis as well, is considered to be more appropriate.

If you have to choose between HIFO and FIFO accounting methods, two of the most popular methods followed, you will not only need to know the differences between these two methods but also understand how each of them works.

Complicated as it may sound, this article will help you in clearly understanding the differences and choosing the right accounting process for calculating the tax consequences of your crypto portfolio.

This knowledge will also help you to know how the amount paid for your crypto assets on a cost basis has had an impact on the taxes you pay when you sell them eventually.

Crypto HIFO vs FIFO Accounting Methods – The Differences

 

Since the IRS allows the crypto investors and traders to choose the method in which they can calculate their cost basis, you should make the right choice essentially to determine the magnitude of your capital gains and ensure significant tax savings.

In the absence of detailed crypto transaction records, you will not be able to meet the Specific ID requirements, and in that case, it is important to choose the FIFO accounting method for your tax purposes.

However, you may also choose other accounting methods such as HIFO, which is a subset of Specific ID just as LIFO, but for that, you will need to understand the differences between them.

Here they are for you.

Basics

The FIFO accounting method considers the first crypto coin that you purchased which is arranged chronologically when it is counted for sale.

This method is used to calculate the cost basis when the Specific ID requirements are not met. In this accounting method, it is presumed that when you sell off a crypto coin it is the first one that you purchased and stored in your crypto wallet.

On the other hand, the HIFO accounting method involves the selling of those crypto coins first that have the highest cost basis or original cost price.

In this method, the total gain will be the same if it was calculated with the LIFO method, which is why HIFO is considered to be a subset of Specific ID.

The best thing about this method is that when there are hundreds or thousands of trades made, selling on the highest cost basis may result in significant tax savings.

Information Requirements

In the FIFO method, a capital gain is calculated on the purchase price of the one coin that you purchased and sold first.

For calculating the cost basis with this method, you will need only the information regarding the cost price, selling price, and the sequence of entry in the table of crypto coins.

On the other hand, if you follow the HIFO accounting method, then, according to the guidelines laid by the IRS, you will be allowed to use a specific identification method provided you have all the necessary information.

This includes the date and time of the unit acquired the fair market value and the basis of each coin acquired, the date and time each coin was sold, disposed of in any other way or exchanged.

You will also need the fair market value of such coins sold, exchanged or disposed of otherwise as well as the value of property or amount of money received against each coin that is sold.

Capital Gains

You can differentiate FIFO and HIFO accounting methods in terms of capital gains and get help when you need to make a choice between them. Ideally, the FIFO method will result in the highest capital gains in a Bull market.

This market is usually trending up and therefore the prevailing market price of the coin in question is usually higher than the initial purchase price of it.

And, since in the FIFO method you sell off the oldest coins first, it automatically results in a higher capital gain.

And, on the other hand, when the price of a particular crypto coin is lower than the initial purchase price and is still declining, the FIFO method can lower the capital gains.

This is because the initial cost price will be higher than the current prices at which you are selling the crypto coin.

On the other hand, when you use the HIFO method for calculating your crypto taxes, it will always result in the lowest capital gains possible.

This is because each of your transactions will consider the highest available cost basis which will lower your taxes to the maximum.

Safety Aspects

Ideally, the FIFO accounting approach is also considered to be the safest to reduce the risk of underpayment penalties that may be imposed by the Internal Revenue Service since those assets that were first taken in are disposed of first. This gives the crypto users the highest possible taxable gain.

In contrast, the HIFO method is not used often because it is not recognized by GAAP or the Generally Accepted Accounting Principles as a standard practice.

Moreover, there is another significant aspect that causes a bit of a concern when the HIFO accounting method is used. It is that the process always undervalues the stock. This means that there is a great opportunity to create secret reserves.

Which is Better – Crypto HIFO or FIFO Accounting Method?

The answer to this question may vary because the whole thing depends on the particular situation and your needs.

It will be better for you to decide for yourself which among the two accounting methods you should choose by breaking down the benefits offered by each of these methods.

In addition to that, you will also need to know a few other facts regarding these two accounting methods as you can see that the differences between them are not too many to help you to make a proper and precise comparison between the two.

First, in order to know the significance of the different accounting methods, you will need to know how exactly cryptocurrencies are taxed.

Yes, these are taxed, believe it or not, because the IRS considers the crypto coins to be a type of property.

Therefore, when you sell your crypto holdings, you will be held liable to pay capital gains taxes.

This is typically calculated by using the following formula:

Capital gain = Value at time of sale – Cost basis

If the price of the coin at the point of sale is lower than the cost price, it will result in a capital loss.

This amount can be utilized to make up for the capital gains earned from that particular coin in that particular year.

Now, you should know the importance of the accounting method you choose.

This is quite tricky because depending on the accounting method you will either choose to sell a coin that you bought first or the one that has the highest price tag.

Sometimes, depending on the current market situation, if you choose to sell off the coins with the highest value, you can probably save thousands of dollars in taxes.

Now that you know these basic yet important facts about both HIFO and FIFO accounting methods, you will find it easy to choose the method that is best in your case.

As said earlier, using the HIFO accounting method instead of FIFO will enable you to save a lot on your tax bill.

This is considered to be the most useful and effective method for minimizing taxes on crypto coins.

The uniqueness of this method is that the calculation will result in the largest capital losses and lowest capital gains.

This will offset your income considerably in the current year and the leftover will be carried forward to the following tax years.

However, this particular method can only be fruitful if you maintain detailed records of all your crypto transactions.

However, on the other hand, the FIFO accounting method is favored by most of the crypto investors because it is considered to be a safe and most conservative approach.

Assuming that you have chosen the FIFO accounting method to calculate the taxes on your crypto transaction, there is no reason to believe that you cannot switch over to the HIFO method at a later point in time.

However, for that, you will need to identify the crypto units that you are selling very specifically.

One good thing is that in the tax report you are not required to mention the particular accounting method you have used to calculate your capital gains or losses.

All you need is to be sure to prove all the necessary and relevant information when you need to substantiate your tax calculations in case your tax return gets scrutinized.

In a nutshell, it can be said that HIFO is the preferred method if you want to pay the lowest amount of taxes on your crypto transaction and have all the records of them maintained precisely.

On the other hand, the FIFO method is good for those crypto investors who wish to move to a low tax year or want to cash out their positions based on a lower tax rate.

Now, you may tend to think that the HIFO accounting method is the best to choose for you, but, try a little because it is not that simple to make a choice.

You will need to consider a few specific things before you finally make your choice.

One, you should check with the local tax authority for the rules and regulations in your country whether or not you are allowed to use cost basis methods.

This is because a few countries still impose some regulations on using the cost basis method while calculating tax amounts and have specific guidelines in place for crypto tax calculations especially.

Two, you should also check whether or not the tax regulations in your country allows a specific tax calculation method for your crypto transactions simply based on the identification of the unit of coins sold or includes the time period as well along with it for which you owned that particular coin before selling it to make a profit.

Remember, according to the prevailing local tax rules, if you make short term gains on your crypto assets that you held for less than a year you may be taxed at a much higher rate in comparison to those that you owned for more than 6 months.

Also, you should keep a track of both your short term and long term gains along with your tax liability according to HIFO, FIFO, LIFO, as well as other cost basis methods.

Apart from that, you will need to keep a proper track of the entire transaction process but it may be quite difficult and elaborate if you have more than 30 transactions and maintain the records in a simple spreadsheet such as Excel.

This will be a bit adventurous and will also need you to spend a lot of time on it to keep a proper track of all your trades and transactions made all through the days, weeks, and months.

In that case, it will be a much sensible decision to make the best use of one of the available crypto tax solutions that will help you to automate the entire process.

These solutions will also help you to generate your tax report very easily for your crypto transactions using one of the FIFO or HIFO cost basis methods.

Finally, no matter whichever accounting method you choose you should be consistent and stick to the particular method you picked.

Though you are not barred from switching from one method to another accounting method, it is quite difficult and you will also need a proper authorization from your local tax agencies.

Last but not least, always talk to your accountant because they are the best ones to know and deal with all the complicated aspects of tax and they specialize in crypto tax solutions.

They will help you to choose the best strategy for you which will work best in the given conditions and together with them you will be able to move forward easily and confidently minimize your tax liability in the long term.

Conclusion

By now it should be clear to you that calculating crypto taxes is very difficult. Add to that, accounting methods like HIFO and FIFO can surely confuse you a lot, but not anymore now that you know about them in detail after reading this article.