When it comes to reporting your crypto taxes, how you calculate your gains and losses is just as important as what you report to the authorities. With investors having the option to choose from methods such as FIFO and LIFO (last-in, first-out), it is clear that there is no one-size-fits-all solution for your accounting needs. That being the case, you have to make a judgment call, and the method suits your needs and goals best. In this blog, we will be talking about LIFO in crypto accounting, when it can be effective, when it’s not, and how an experienced crypto CPA determines whether LIFO is the right fit for you.
What is LIFO?
LIFO, which stands for ‘Last-in, First-out’ is a tax and accounting method that is used to calculate gains and losses in cryptocurrency under the assumption that the last cryptocurrency to enter your digital wallet would be the first currency to leave the wallet.
How does LIFO work in crypto accounting?
LIFO can come into effect when you buy the same cryptocurrency on different dates at different price points. For example, Adam purchases 1 Bitcoin each on 1st January and 1st February for $30,000 and $45,000 and subsequently sells 1 Bitcoin on 1st March for $50,000.
When we calculate Adam’s capital gain for the sale on 1st March, under LIFO, we assume that the BTC to leave the wallet will be the last one he purchased on 1st February. That being said, Adam’s capital gain will be as follows:
Sale price ($50,000) – Cost basis ($45,000) = Capital gain ($5,000)
Alternatively, if we used FIFO, the cost basis would be the value of the BTC purchased on 1st January. In such a situation, Adam’s taxable capital gain would be as follows:
Sale price ($50,000) – Cost basis ($30,000) = Capital gain ($20,000)
Therefore, if someone is looking to reduce their crypto tax profile, especially in a rising market, LIFO would make the most sense.
When should you consider LIFO in crypto accounting?
- Bull markets—The term “bull market” is often used to refer to markets where prices are steadily on the rise. In a bull market, your newest purchase would have the highest cost, and as we’ve shown, selling it first can reduce your tax profile.
- Active traders—If you are someone who actively deals in crypto and other digital assets, you can accumulate your assets at a higher price and sell them off quickly to reduce the tax on your gains.
- Tax planning—One of the core objectives of tax planning is reducing your overall tax liability. That being the case, LIFO is one of the best models to adopt to achieve that goal.
When should you avoid LIFO in crypto accounting?
- Bear markets—While bull markets refer to climbing markets, “bear markets” refer to markets where prices are on a downward trend. In such a market, using LIFO might subject you to lower gains or larger losses.
- Advanced record-keeping—If you’re not looking to track specific assets or are more passive with how you handle your digital assets, then the simplicity of first-in, first-out will work just fine.
Conclusion
When it comes to reducing your tax profile, LIFO can be a powerful strategy when used correctly, under the right market conditions. However, receiving the full benefits of LIFO requires investors and traders to maintain meticulous records, which will require the skills and expertise that only a professional cryptocurrency accountant can provide. If you’re looking for such an accountant, then Onchain Accounting is the firm for you. Contact us today and schedule your appointment with us.
