Cryptocurrency Tax Calculations - FIFO vs. LIFO explained
When calculating your capital gains and losses for your cryptocurrency transactions, you need to use a consistent costing method. The most conservative and universally accepted method in the world of cryptocurrency taxes is first-in-first-out (FIFO). Another common one that traders typically ask about is last-in-first-out (LIFO). This article explains each of these costing methods and how they work.
How is cryptocurrency treated for tax purposes?
According to the official IRS guidance released in 2014, cryptocurrencies are treated as property for tax purposes. Just like other forms of property—stocks, bonds, real estate—you incur a tax liability when you sell cryptocurrency for more than you acquired it for.
For example, if you purchased 0.1 Bitcoin for $1000 in April of 2018 and then sold it two months later for $2,000, you have a $1,000 capital gain. You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on if it was a short term vs. a long term gain.
On the flip side, if you sold your cryptocurrency for less than you acquired it for, you can write off that capital loss to save money on your crypto taxes. Either way, if you incur a taxable event during the year, you need to report your cryptocurrency on your tax return.
Which costing method am I allowed to use?
In the United States, the IRS has not released any explicit guidance for which capital gains calculation method should be used for cryptocurrency transactions. However, because the IRS classifies crypto as property, tax professionals often look to Publication 550 which discusses how other forms of property like stocks, bonds, and mutual funds should be treated.
If we apply this guidance to cryptocurrency, it states that there are two options for calculating capital gains: first-in-first-out (FIFO) and specific identification.
The simplest and most conservative method is FIFO, which is what CryptoTrader.Tax provides by default.
With specific identification, you identify exactly which coin is being spent at transaction time. This can be ad-hoc or according to a pattern (last-in-first-out [LIFO], highest-in-first-out [HIFO], etc.).
Using first-in-first-out is exactly how it sounds. The first coin that you purchase (chronologically) is the first coin that is counted for a sale.
You buy 10 ETH on Coinbase on January 15th, 2018 for $500 each. Two weeks later, you buy 3 more for $600.
In June 2018, you sell 5 ETH for $3,000 total.
To calculate your gain on this transaction, you need to know at what price you purchased those ETH.
Because we are using FIFO, the purchase price of those 5 ETH that you sold will be $2,500 as each one was purchased for $500 in the first group that you bought (5 * $500).
Doing the math then:
$3,000 (selling price) - $2,500 (purchase price or cost basis) = $500 capital gain.
As you can see, by using FIFO, we sell the coins that we purchase first. First in, first out.
You can likely imagine how LIFO works. It’s simply last-in-first-out.
Let’s use the exact same example from above.
In this case our cost basis or purchase price of the ETH we sold in June would be $2,800 ($600 + $600 + $600 + $500 + $500).
Doing the math then:
$3,000 (selling price) - $2,800 (purchase price or cost basis) = $200 capital gain
As you can see, we pull from the last coins we bought, in this case we bought 3 ETH for $600, so we sell these first. Once that group is gone, we sell the 2 ETH that were bought for $500.
It’s important to note that the IRS likes to be retroactive when it issues guidance. For instance, Notice 2014-21, which classified cryptocurrency as property rather than currency, was issued in 2014, but still applied to transactions taking place before 2014. Future guidance on the FIFO, LIFO, specific identification issue will likely also be retroactive to prior filed returns. This is why most of the cryptocurrency tax professionals we have worked with typically recommend the most conservative approach of universal FIFO.
Using other costing methods is more aggressive and risky. Be prepared to have a defensible position if you chose to go with an alternative, specific costing method.
Please consult a tax professional that is familiar with digital currencies with questions on any aggressive positions you plan on taking.
Crypto Tax Software
You can automatically calculate and report your complete crypto tax liability by using crypto tax software like CryptoTrader.Tax.
CryptoTrader.Tax is the leading cryptocurrency tax preparation platform used by over 13,000 crypto enthusiasts to handle their crypto taxes. Simply upload your crypto transaction history into the platform and automatically generate your necessary crypto tax reports. You can give these reports to your tax professional or simply upload them into your tax filing software like TurboTax or TaxAct.
*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.