FIFO, LIFO, and HIFO - What’s the best method for crypto?

FIFO, LIFO, or HIFO - which accounting method is the best for cryptocurrency? 

While the answer may vary based on your specific situation, this guide will break down the benefits of each method with the help of a few simple visual examples. By the time you finish reading, you’ll better understand which accounting method can help you save money during the tax season.

How is cryptocurrency taxed? 

To understand the importance of accounting methods, it’s helpful to know how cryptocurrency is taxed. 

The IRS considers cryptocurrency a form of property. When you sell or otherwise dispose of cryptocurrency, your gains will be subject to capital gains tax.

You can use the following formula to calculate your capital gains:

In this case, your proceeds are how much you received for disposing of your cryptocurrency. Meanwhile, your cost basis is your cost for acquiring cryptocurrency.

If the value of your tokens at the time of sale is lower than your purchase price, you’ll end up with a capital loss, which can be used to offset capital gains for the year. For more information, check out our article on tax-loss harvesting. 

What is an accounting/cost basis method? 

If you’ve bought your cryptocurrency at multiple price points, it may be difficult to determine your cost basis. In this case, you’ll need to use an accounting/cost basis method to determine your capital gains at the time of disposal.

Why does your accounting method matter? 

To better understand why accounting methods are important, let’s take a look at an example.

Depending on the accounting method James chooses, he will either be selling the BTC he purchased for $20,000 or the BTC he purchased for $50,000.

If James chooses the former option, he will have $40,000 of capital gain. If he chooses the latter option, his capital gain will be only $10,000.

While your situation may not be exactly the same as James’s, it’s possible the accounting method you choose can significantly reduce how much you pay in taxes. 

How do FIFO, LIFO, and HIFO work?

FIFO (first-in-first-out), LIFO (last-in-first-out), and HIFO (highest-in-first-out) are simply different methods used to calculate cryptocurrency gains and losses. 

To better understand how they work, let’s calculate capital gains on the following transaction using each one of these different accounting methods. 

Below, we’ll break down how you can calculate your capital gain using FIFO, LIFO, and HIFO.

What is FIFO?

With first-in-first-out, the first coin that you purchase (chronologically) is the first coin that is counted for a sale.

How do you calculate capital gains with FIFO? 

If we apply FIFO to the example above, the purchase price of the 1 ETH that you sold in August will be $2,250. That’s the cost basis of the first token that you bought. 

We can use that information to calculate your capital gains. 

What are the advantages of FIFO? 

FIFO is considered the ‘default’ accounting method. As a result, it’s the method used by most investors to calculate their capital gains. 

In addition, if the price of your cryptocurrency has dropped since you first purchased it, using FIFO may help you reduce your capital gains. In a period of falling prices, the cryptocurrency you acquired first will be the units with the highest cost basis. 

What is LIFO? 

With last-in first-out, the last coins that you acquired will become the first coins that you sell. 

To illustrate this further, let’s use the exact same example from above.

Using LIFO, our cost basis (or original purchase price) of the ETH we sold in August would be $2,500. That’s the cost basis of the last token that you bought. 

Doing the math then:

In the example above, using LIFO instead of FIFO would save you $250 in capital gains. 

Is LIFO better than FIFO? 

The accounting method that works best for you can vary based on market conditions. In a period of rising cryptocurrency prices, using LIFO will most likely lead to significantly less total taxable gains. In a period of falling prices, FIFO will most likely yield better results. 

What is HIFO? 

With highest-in, first-out (HIFO), you sell the coins with the highest cost basis (original purchase price) first.

In our example above, HIFO would lead to the same total gain as LIFO. In this case, the last cryptocurrency acquired is also the one with the highest cost basis.

However, in a scenario with hundreds or even thousands of trades, selling your highest-cost basis coins first can lead to significant tax savings.  

HIFO can be used as a “tax minimization” method as it will lead to the lowest capital gains and the largest capital losses. Keep in mind, net capital losses can be used to offset other income up to $3,000 dollars (the remaining will be carried forward to future tax years).
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What is a ‘specific ID’ accounting method? 

LIFO and HIFO are considered ‘Specific Identification’ methods. 

According to IRS guidance, you can use a specific identification method like LIFO or HIFO if you have records containing the following information:

1. The date and time each unit was acquired.
2. Your basis and the fair market value of each unit at the time it was acquired.
3. The date and time each unit was sold, exchanged, or otherwise disposed of.
4. The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.

Which accounting/cost basis method will lower my tax bill the most?

Because HIFO sells your cryptocurrency with the highest cost basis first, this method is typically considered the best for saving money on your taxes.
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What is the best cost basis method?

The best cost basis method for you may vary depending on your specific situation. 

FIFO is used by most investors since it is considered the most conservative accounting method. While methods like HIFO and LIFO can reduce your tax bill, they should only be used if you’ve kept detailed records of your crypto transactions. 

If you’re looking to track your cryptocurrency trades across multiple wallets and exchanges, get started with CoinLedger. More than 300,000 investors use the platform to generate a comprehensive tax report in minutes.

Can I switch my accounting method? 

Switching from one accounting method to another on a year-to-year basis is allowed by the IRS.

However, flipping back and forth between methods may lead to calculation errors, which can be a red flag for the IRS to investigate further.

You should talk to your tax professional to see if switching your accounting method is right for you.

Find the right cost basis method for you 

Cryptocurrency tax software like CoinLedger can automatically handle all of your cryptocurrency tax reporting. Simply upload your crypto transaction history into the platform and generate your necessary crypto tax reports with the click of a button.

The platform supports several different cost basismethods like FIFO, LIFO, and HIFO. 

Get started with a free preview report today. You don’t need to enter your credit card information until you’re 100% sure your transaction information is accurate! 

Frequently asked questions

Let’s take some time to answer a few frequently asked questions about HIFO, FIFO, and LIFO. 

Can I use HIFO for crypto? 

Yes. The IRS’s guidance states that crypto investors can use HIFO provided that they keep detailed records and can identify specific units of cryptocurrency. 

Can I change calculation methods from year to year? 

Yes. IRS guidelines allow investors to change calculation methods from year to year. However, you need to keep detailed records of your transactions and properly account for each sale.

What accounting method should I use for my crypto? 

While American crypto investors can use accounting methods like FIFO, LIFO, and HIFO, many choose to use FIFO because it is considered the ‘default’ option. 

Is HIFO better than FIFO? 

The ‘best’ accounting method for cryptocurrency varies depending on the facts and circumstances of your situation. In most situations, HIFO can reduce your tax bill, but you’ll need detailed records of your transactions to be able to specifically identify the crypto you’re disposing of. 

Does Coinbase use LIFO or FIFO? 

Coinbase allows users to select their accounting method through their settings on their account. You can choose FIFO, HIFO, or LIFO. 

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*This post is for informational purposes only and should not be construed as tax, investment, or legal advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.