When tax season comes, you have a choice to make: FIFO or LIFO—what accounting method will serve you best? In this article, the team at Onchain Accounting, embracing the role of your crypto CPA, will describe these methods, break down their pros and cons, and help you understand which accounting method can help you save more this tax season.
How Are Cryptocurrencies Taxed?
Before we discuss the pros and cons of FIFO and LIFO, it’s helpful to know how cryptocurrencies are taxed. The IRS considers cryptocurrencies and other digital assets as property rather than currency.
This means activities such as selling crypto for fiat currency, exchanging one crypto for another, using crypto to pay for goods or services, and receiving crypto as an income are taxable events, subject to capital gains tax.
What Is FIFO?
FIFO stands for first-in, first-out. This method looks into the chronology of your crypto assets, with the first coin you purchase being the first coin that is counted in a sale.
For example, consider that you’ve purchased 0.5 BTC for $20,000 on January 1st, 0.5 BTC for $30,000 on March 1st, and 0.5 BTC for $40,000 on June 1st. You currently possess 1.5 BTC, and you choose to sell 0.5 BTC on 1st November for $45,000. Under FIFO, the IRS will consider that you’ve sold the BTC you acquired on 1st January. In the end, there will be a taxable gain of $25,000.
What Are The Pros And Cons Of FIFO?
Pros
- Simplicity and ease of use—FIFO is a straightforward method and easy to implement, as it follows the chronological order of transactions, allowing for simplified record-keeping and calculations.
- Regulatory acceptance—The FIFO method is the most widely accepted, sometimes the default method that tax authorities use in many jurisdictions.
- Potential for lower long-term capital gain rates—Selling the oldest assets first can help you qualify for potentially lower long-term capital gains tax rates.
- Advantages in failing markets—In declining markets, FIFO can match the sale to older, potentially higher-cost assets, contributing to lower taxable gains or even a capital loss.
Cons
- Higher taxable gains in rising markets—In rising markets, the oldest assets have the lowest cost basis, resulting in higher capital gains and larger tax liabilities.
- Limited tax loss harvesting flexibility—FIFO’s rigidity does not allow investors to strategically select specific assets to sell and reduce their tax burden through tax loss harvesting.
What is LIFO?
Under the last-in, last-out method, the last coin you acquired becomes the first coin you sell.
For example, consider a situation where you purchased 1 ETH on January 1st, March 1st, and June 1st for $1500, $2000, and $3000 respectively. When you choose to sell 1 ETH for $3500 on 1st November, under LIFO, the IRS will treat the ETH you purchased on 1st June as the one you sold. Based on the numbers in this example, your taxable income will be $500.
What Are The Pros And Cons Of LIFO?
Pros
- Lower immediate tax liability – In rising markets, since LIFO assumes the most recent and higher-cost purchase as the one sold first, it is a smaller taxable gain compared to selling older, cheaper assets.
- Greater retention of capital – With lower taxable gains, you are allowed to retain more capital that you can use to reinvest.
Cons
- Short term capital gains – Short term capital gains are taxed at a higher rate compared to ordinary income rates and long-term capital gains tax.
- Requirement of accurate record keeping – Without accurate record-keeping, the system can be difficult to implement and not readily enforced in most jurisdictions.
- Can complicate long-term tax planning – Due to newer assets being sold first, it can complicate long-term tax planning as older coins continue to sit in your portfolio.
Which Is better: FIFO Or LIFO?
When comparing the two methods, we cannot say that one method is objectively better than the other. This is because both FIFO and LIFO shine in different circumstances. FIFO can be viewed as a better accounting method for long-term investors for its emphasis on chronology, simple documentation, and consistent method across exchanges.
On the other hand, LIFO is ideal for active traders that focus on short-term trades and focus on smaller gains. In the end, the method you choose will depend on your priorities.
Conclusion
Making a choice between FIFO and LIFO is much more than a tax preference—it is a strategic choice that meaningfully impacts profits, tax liabilities, and short-term and long-term investing outcomes. With both methods having their pros and cons, what is the “best” strategy ultimately depends on you.
In a fast-paced environment with accurate record-keeping and market analysis, proactive crypto accounting is a must, and Onchain Accounting is ready to help. Our team can help you analyze trading patterns, model tax outcomes, and help you choose the approach that aligns with your financial goals. Contact us, schedule your consultation, and benefit from unmatched professional support that can help you grow and avoid costly mistakes.
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Disclaimer
This article is for general informational purposes only and does not constitute tax, financial, or legal advice. Cryptocurrency tax treatment can vary based on individual circumstances and changing IRS guidance. Readers should consult a qualified tax professional or CPA before making decisions based on this content. The author and publisher assume no responsibility for actions taken based on the information provided.
