How HIFO Accounting Reduces IRS Billing

Bitcoin has fallen about 36% from its all-time high in November, but the tax habits that help crypto holders protect their winnings from the IRS have a positive side to this decline.

The IRS treats cryptocurrencies like property. That is, whenever you use, redeem, or sell a token, you log taxable events. There is always a difference between the amount paid for crypto, which is cost-based, and the market value when using it. The difference can cause capital gains taxes.

However, a lesser-known accounting method known as HIFO (short for high-in, first-out) can significantly reduce investors’ tax obligations.

When you sell your cipher, you can choose and choose the specific unit you are selling. This means that crypto holders can pick out the most expensive Bitcoin they have purchased and use that number to determine their tax obligations. A higher cost base translates into less tax on your sale.

However, thorough bookkeeping is essential because the user is responsible for tracking. Without detailed taxpayer transaction and cost-based records, the calculation to the IRS cannot be substantiated.

“People rarely use it because they need to keep good records and use crypto software,” said, Chief Accountant and Chief Strategy Officer of crypto tax software company. Shehan Chandrasekera explained. “But now that many people use that kind of software, this kind of accounting is very easy. They just don’t know it exists.”

The secret of HIFO accounting is to keep details about all cryptocurrency transactions made for each coin you own. This includes when and how much you bought, when you sold and the market value at that time.

However, if all transaction records are not logged, or if you are not using the appropriate type of software, the accounting method defaults to what is called a FIFO, or first-in, first-out method.

“It’s not ideal,” explains Chandra Sekera.

According to the FIFO accounting rules, when you sell tokens, you sell the coins you bought the earliest. If you buy cryptocurrencies before they reach high prices in 2021, the low cost base can result in higher capital gains tax charges.

Next, there are wash sale rules

Experts tell CNBC that taxpayers could save even more money by combining HIFO accounting and wash sale rules.

According to Tyrone Ross, CEO of Onramp Invest, the IRS classifies digital currencies such as Bitcoin as assets, so losses from holding cryptocurrencies are treated differently than losses from stocks and investment trusts. In particular, the wash sale rules do not apply. This means that you can sell Bitcoin and buy it back immediately, but if it is in stock, you have to wait 30 days before buying it back.

This nuance of tax law paves the way for aggressive tax loss harvests, where investors sell at losses and buy back Bitcoin at lower prices. These losses may be used to reduce tax charges or offset future profits.

For example, suppose a taxpayer buys one Bitcoin for $ 10,000 and sells it for $ 50,000. This individual will face a taxable capital gain of $ 40,000. But if this same taxpayer had previously harvested a loss worth $ 40,000 in a previous crypto transaction, they could offset the taxes they incur.

“You want to look as poor as possible,” explained Chandra Sekera.

Chandra Sekera says she sees people doing this weekly to quarterly, depending on their sophistication.

Repurchasing crypto quickly is another important part of the equation. If the timing is right, buying a dip can help investors regain their ride quality if the price of digital coins rebounds. How HIFO Accounting Reduces IRS Billing

Back to top button