After years of delays, the first stage of the Corporate Transparency Act (CTA) goes into effect on January 1, 2024. It imposes a new federal filing requirement for Consider this happy scenario: You purchased one Bitcoin for $15,000 14 months ago and another six months later for $40,000. Today, you sell one Bitcoin for $60,000. You’re a genius! But is your taxable gain $45,000 or $20,000?
It all depends on your crypto accounting method.
Many crypto owners are enjoying substantial gains at a time of surging cryptocurrency prices. When you sell multiple crypto units in the same year, you reduce your taxable gains using a crypto accounting method that provides the highest possible tax basis for each unit sold, resulting in the lowest taxable profit.
As you might expect, the default method approved by the IRS doesn’t always provide the highest basis, resulting in higher taxes. The IRS made FIFO (first in, first out) the default method. It requires you to calculate your basis in chronological order for each crypto unit sold. With FIFO, your basis in the above example is $15,000, and your taxable profit is $45,000.
You can use a method other than FIFO. The other methods are called “specific identification methods” and include HIFO (highest in, first out) and LIFO (last in, first out). With HIFO, you are deemed to sell the crypto units with the highest cost basis first; your basis in the above example would be $40,000, and your taxable profit only $20,000.
Because HIFO sells your crypto with the highest cost basis first, it ordinarily results in the lowest capital gains and the largest capital losses. But using HIFO can cause loss of long-term capital gains treatment if you have not held the crypto for more than one year.
Using HIFO or LIFO is more complicated than using FIFO. You must keep records showing
- the date and time you acquired each crypto unit,
- your basis and the fair market value of each unit at the time it was acquired,
- the date and time each unit was sold or disposed of, and
- the fair market value of each unit when sold or disposed of.
If you lack adequate records, the IRS will default to the FIFO method during an audit, which could result in more taxable profit.
It’s next to impossible to manually create the needed crypto records, particularly if you have many trades. Most crypto owners use specialized crypto tax software that automates the basis and gain/loss calculations and can even fill out the required tax forms.You can change your crypto accounting method from year to year without obtaining IRS permission—for example, you can change from FIFO to a specific identification method such as HIFO. You don’t have to disclose which method you use on your tax return.
If you’d like assistance with potentially reducing your capital gains tax from crypto sales, please call us at (818) 600-4494.