FIFO, OPTI, or HIFO for crypto taxes? There are many accounting methods used to calculate capital gains in the US. Many other methods such as HMRC or ACB are available to calculate gains when trading crypto if you’re in the UK, Canada, or Australia.
The choice of accounting methods changes your capital gains, resulting in different tax bills at the end of the year. Today, we explore which accounting methods are eligible in the US while showing you simulations reflecting the impact of choosing FIFO or OPTI as accounting methods on your final crypto tax expense.
Check our ultimate US crypto taxes guide for clarification on most taxable scenarios when trading crypto.
Which accounting method to choose for crypto taxes? Can I avoid FIFO in the US?
In the US, you can select “FIFO“ (First-in, First-out) or “Specific Identification“ as accounting methods for crypto taxes. With FIFO, the first crypto batch you acquired will be the first one to be sold, meaning to calculate capital gains, you will select the price of your first purchase. If the purchase price is much lower than the selling price, the capital gains will be more than if you used another crypto purchased price that was higher.
For investors looking to lower their current tax bill, they would prefer to choose a batch of crypto they acquired at a higher price to get smaller capital gains at this time. If you want to pick a different tax lot than the first one you acquired, you’ll have to choose “specific identification.”
However, once you pick a method, you are required to apply it to all your coins and for all the upcoming years. You can only change methods if you file an application for an accounting method change and get it approved by the IRS.
Can I use LIFO instead of FIFO for crypto taxes?
FIFO or LIFO for cryptocurrency?
LIFO refers to “Last-in First-out.” If you use LIFO, you pick the last set of coins that you purchased to calculate the capital gains when selling. It is beneficial to use LIFO if you acquired crypto multiple times, the market price has been going up, and you want to use the highest cost basis possible.
As a result, when you sell, the tax burden would be lower for that year since your cost basis was higher with LIFO when compared to FIFO. However, the IRS doesn’t authorise LIFO to calculate crypto gains/losses in the US.
Here’s how to calculate taxes with different accounting methods.
For this example, let’s assume that Marie bought Bitcoin 3 times in 2020. Each time, Marie purchased 0.5 BTC at different prices. Marie bought 0.5 BTC each month at the following prices:
Marie purchased 1.5 BTC in total but at different prices, meaning she has three different cost basis. As a result, depending on the accounting method chosen, the capital gain amount will change. For the calculations below, let’s assume Marie is going to sell 0.5 BTC in September 2021. Let’s also assume that the price of 1 Bitcoin is $50,000 in September 2021. Now, let’s see the scenarios of calculating crypto taxes under FIFO, OPTI, and HIFO.
Calculating crypto taxes using FIFO
Using FIFO for crypto taxes, Marie’s cost basis will be the first 0.5 BTC she purchased in 2020. In this case, it is the purchase Marie made in March 2020 when 1 Bitcoin was $6,000. This decision will lead to the highest capital gains for Marie since that is the lowest basis cost of all her purchases.
As a result, her cost basis in USD will be $3,000 (0.5 BTC*$6,000) using FIFO, but how about the final gains and crypto taxes bill?
Her total sale proceeds will be $25,000 (0.5 BTC*$50,000).
As a result, her capital gain for this sale will be $22,000 ($25,000-$3,000).
Since she bought the 0.5 BTC in March 2020 and sold it in September 2021, the $22,000 is a long-term gain. Assuming Marie’s long-term capital gain tax rate* is 15%, she will need to pay $3,300 (=$22,000 x 15%) in crypto taxes for the gain under FIFO. Check the tax benefits of long-term crypto holding.
Now, let’s see the difference in the capital gains calculation and you crypto taxes when using a different accounting method than FIFO.
Calculating crypto taxes using OPTI (“Specific Identification”).
Using OPTI (Optimized Method), Marie can pick a tax lot that will result in the lowest tax liability for her among the BTC purchases she made in 2020. In this case, Marie should use her cost basis for the purchase she made in August 2020 when 1 Bitcoin was $12,000. This decision will lead to the lowest tax liability for her, as explained below.
Under OPTI, her cost basis in USD will be $6,000 (0.5 BTC*$12,000).
Her total sale proceeds will be $25,000 (0.5 BTC*$50,000).
As a result, her capital gains for this sale will be $19,000 ($25,000-$6,000).
Since she bought the 0.5 BTC in August 2020 and sold it in September 2021, the $19,000 is a long-term gain. Assuming Marie’s long-term capital gain tax rate is 15%, she will need to pay $2,850 (=$19,000 x 15%) in taxes for the gain.
Is HIFO better than FIFO for crypto taxes?
Some people think that HIFO (Highest In, First Out) is the best method. Even if you can argue that HIFO is a specific identification method, it is not as good as OPTI because it does not consider the holding period. Under HIFO, you have to pick the tax lot with the highest cost basis, regardless of the holding period. Consequently, you may end up with a lower short-term gain, but it may result in higher tax liability due to being taxed at a short-term capital gain tax rate instead of long-term.
Furthermore, it is debatable if HIFO is a true specific identification method because you don’t have the flexibility to truly pick whichever tax lot you want. With HIFO, you have to pick the highest cost basis rather than having the flexibility to pick a different tax lot that may result in a lower tax liability due to long-term tax setting.
An example: Crypto taxes with HIFO instead of OPTI
In this example, if Marie used HIFO instead of OPTI, she would have to use her cost basis for the 0.5 BTC she bought in December 2020 when the price was $15,000. Her gain would be $17,500 (=0.5 BTC x $50,000 – 0.5 BTC x 15,000), which is lower than the $19,000 gain calculated under OPTI. However, since she bought the BTC in December 2020 and sold it in September 2021, the gain is short-term. Assuming her ordinary tax rate is 35%, she will need to pay $6,125 (= 17,500 x 35%) in taxes, which is much higher than the $2,850 taxes she needs to pay under the OPTI method.
CoinTracking is one of the very few, if not the only, crypto tax software in the market that can use its algorithm to pick the best tax lots under OPTI to get you the best result for your crypto capital gain/loss calculation. Most other similar software only offers FIFO, LIFO (not an IRS permissible method), and HIFO for crypto taxes.
Careful tax planning and attention to holding periods
Please note that regardless of the accounting method you use, your total cost basis is the same in the end. In the beginning, if you pick a method that gives you a lower gain, you can expect a higher gain later because your remaining tax lots would have a lower basis. You can postpone your taxes, but you can’t avoid them. Of course, as the saying goes, time is money. It’s always better to pay less tax now, keep the money for yourself longer, and push the higher tax liability to later, as long as it’s a legitimate tax-saving strategy.
As always, consult a qualified crypto tax CPA in your country for careful tax planning when trading crypto due to its high volatility. Keep in mind that your holding period and accounting method impact your seasonal tax bill, increasing the need to track trades and prepare crypto tax seasons. For all details on how to report your crypto taxes, check our comprehensive guide.
*This post is part of the Crypto Taxes AMA series. Follow our weekly AMAs on Twitter where our expert CPA, Sharon Yip answers your crypto tax questions.
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Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.