FIFO, LIFO, & HIFO: Crypto Accounting Methods 2024

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

While accounting methods can be difficult to understand, this article will break down the pros and cons of each method with the help of a few simple infographics. By the time you finish reading, you’ll understand which accounting method can help you save the most 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. 

When you dispose of cryptocurrency, you’ll incur a capital gain or loss depending on how its price changed since you originally received it. If you make a profit, your gains will be subject to capital gains tax. 

If the value of your crypto 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.

How to calculate your capital gains and losses 

You can use the following formula to calculate your gain/loss:

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.

Need help estimating your gains and losses? Try our free crypto tax calculator.

What is an accounting/cost basis method? 

An accounting/cost basis method helps you determine the order in which you dispose of your cryptocurrency. In situations where you bought your cryptocurrency at multiple price points, you’ll need to use an accounting/cost basis method to determine your capital gains and losses.

Why does your accounting/cost basis method matter? 

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

Remember, James’s accounting method determines the order in which he sells his cryptocurrency.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 three accounting 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 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 was acquired. 

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. 

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. 

In addition, it’s important to remember that gains from cryptocurrency disposed after a year or more of holding are taxed at a lower rate. Since FIFO disposes of your longest-held cryptocurrency first, the method can help you take advantage of the long-term capital gains tax rates!

What is LIFO? 

With last-in first-out (LIFO), the last coins that you acquired will become the first coins that you sell. In a period of rising prices, LIFO can help you save money on capital gains tax. 

Let’s see what would change if we use LIFO instead of FIFO for the example 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? 

It’s important to note that using LIFO does not always lead to less capital gains than using 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. 

In addition, it’s important you should take into account how the holding period of your cryptocurrency may impact your tax bill before using LIFO. 

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 or disposed of.
4. The fair market value of each unit when sold or disposed of.

What is the average cost basis accounting method? 

In countries like Canada, your cost basis for cryptocurrency is your average cost for acquiring your coins. However, the average cost basis method is not permitted in the United States. 

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.

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 500,000 investors use the platform to generate a comprehensive tax report in minutes.

CoInLedger can connect to your wallets and exchanges to help you easily track your cost basis for all of your cryptocurrencies. The platform also allows you to choose your preferred accounting method!

Can I switch my accounting method? 

You are allowed to switch accounting methods from year-to-year. 

However, you should be cautious before switching your accounting methods because of potential calculation errors. For example, if you use FIFO in one year and HIFO in the next, you may use the same cost basis from the same batch of cryptocurrency. This is considered incorrect — if your transactions are scrutinized by the IRS, you may be required to pay fines and penalties. 

Before you switch your accounting method, you should speak to a tax professional to discuss whether it is the right move for your unique situation.

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.

CoinLedger allows you to choose your preferred cost basis method. Whether you want to pick FIFO, LIFO, or HIFO — the platform has you covered!

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!