What are the Different Crypto Tax Accounting Methods in the United States?

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What crypto tax accounting methods are commonly used for paying crypto taxes in the U.S.?

If you want to calculate the capital gain in the United States over cryptocurrency, the two most common types of accounting cost basis methods are FIFO & LIFO. 

How would you define the FIFO cost basis method?

FIFO is an abbreviation for “First In, First Out”, which indicates that the sale/purchase of crypto coins are happening on a first-come, first basis. They are purchased in this manner, and they are sold in the same manner as well. In short, FIFO encourages the selling of the oldest purchased coins first.

How would you define the LIFO cost basis method?

LIFO is quite the opposite of FIFO and abbreviates “Last In, First Out.” As the name suggests, LIFO encourages the sale in the opposite order; here, the latest coins are sold first rather than the oldest.  

Which Accounting Method is the Best for Paying Crypto Taxes in the U.S.?

One of the most common methods for calculating capital gains with crypto is FIFO. This means that if you purchase your first bitcoin at a lower price than what it’s worth now and then sell all future purchases throughout any given time, it will have more in profit because those coins were bought later on during said time frame. However – there are also other options available such as “specific identification”, where each coin is taxed separately based on its date/time stamp. In its evaluation, other characteristics are also associated, such as wallet, address, etc., just like an individual stock would do per year. 

Some Crypto currency software or portfolio managers are also available if prefer DIY. Please keep in mind that many situations require a qualified crypto accountant or CPA. 

The LIFO method of accounting for capital gains makes the tax burden lower compared with a more common technique called “FIFO.” LIFO is a beneficial way to calculate your capital gains when selling crypto when the market prices of the cryptocurrency are going up. If you use LIFO, the last set of coins purchased will determine how much taxes are owed for that year since they had a cost basis higher than FIFO compared to other years where there may have been lower prices. 
Unfortunately, the IRS doesn’t allow LIFO for crypto gains/losses in the U.S., which means you cannot lower your taxes with this strategy. Learn about how to report Crypto for personal and business.

What are IRS Notices & Procedures for Such Issues?

The IRS has issued multiple notices and Revenue Procedures to date. For instance, notice 2014–21 and 2014-16 I.R. B938, which classified cryptocurrency as property rather than currency, provides examples of how long-standing tax principles applicable for transactions involving properties apply with virtual currencies., was released in 2014 but still applied before this time too. 

This is why IR-2019 -167, an additional guidance document updated October 9th 2019, provides information about how one should report their taxes regarding crypto assets or face penalties themselves from thereon out when filing forms 1040 & 100x returns.

The IRS has issued a new revenue ruling in IRS Rev. Rul. 2019-24 addressing two issues involving virtual currency. First, does the taxpayer realize gross income due to receiving “hard forks” in cryptocurrency if they do not receive units for them? And secondly, what happens when there is an ‘airdrop’ following so-called hard fork scenarios where people will be rewarded with newer coin types after adoption on blockchains like Bitcoin or Ethereum etc.?
Besides, the IRS has also updated their “Frequently Asked Questions” FAQs to address virtual currency transactions for individuals using cryptocurrency in the form of assets.

Careful Tax Planning Based on Holding Periods

In general, if you pick an accounting method that leads to a lower gain, you can expect to make more money in the long run because your remaining tax lots will have a higher basis. You may defer paying taxes, but you can’t avoid them. Of course, as the adage goes, time is money. It’s always preferable to pay less tax now and save more money longer rather than incur larger tax obligations later, as long as it’s done correctly.
If you were wondering whether or not to trade cryptocurrencies, AKIF CPA has the answer. As usual, tax planning when trading crypto is advisable, owing to its volatility. Keep in mind that your holding period and accounting method impact your seasonal taxes; as a result, keeping track of trades and preparing crypto tax seasons is critical.

Conclusions

As it should be clear now, deciding on the right type of cryptocurrency taxation calculation can be quite convoluted and confusing. Several methods can be used for this purpose. Still, the two we have shared in the following article are the most commonly used and widely accepted methods in the U.S. for calculating cryptocurrency tax. We have also shared which method can provide you with the best results and which are not applicable in the U.S. for tax returns.

It is always preferable to make a well-informed decision now rather than waiting until there is an adverse event downstream – time is money after all!

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