Maximizing Your Crypto Profits: Guide to HIFO Accounting
HIFO (Highest In, First Out) is a cost basis method in crypto accounting that aims to minimize capital gains and maximize losses by selling the highest priced assets first. When comparing HIFO with FIFO and LIFO, there are advantages in immediate tax reporting through increasing the cost basis used.
TL;DR
HIFO (Highest In, First Out) is a method for calculating crypto capital gains that minimizes taxes by selling the highest priced assets first.
It offers tax advantages over FIFO (First In, First Out) and LIFO (Last In, First Out) by maximizing the cost basis, especially in volatile markets.
What is a HIFO cost basis?
HIFO (Highest In First Out) is a cost basis method used for calculating capital gains and losses on transactions in crypto accounting. HIFO is a type of inventory valuation and stock distribution method that follows the concept of selling the highest priced items first, regardless of when they were purchased. With HIFO, the highest priced cryptocurrency assets are sold first when disposing of crypto holdings.
The goal of HIFO is to minimize capital gains and maximize capital losses, as it uses the highest cost basis for the assets sold. This results in the lowest possible capital gains tax liability compared to other methods like FIFO (First In, First Out) or LIFO (Last In, First Out).
How does HIFO differ from FIFO and LIFO?
The key difference is that HIFO prioritizes selling the highest priced assets first to minimize capital gains, while FIFO and LIFO are based on the order of asset acquisition rather than price.
FIFO method assumes the oldest (first) assets are sold first.
LIFO method assumes the newest (last) assets are sold first.
HIFO method assumes the highest priced assets are sold first, regardless of when they were purchased.
How to calculate HIFO for cryptocurrency?
In order to accurately calculate (Highest-In-First-Out) HIFO, the adopter must first identify all the cryptocurrency purchases and their corresponding cost basis (price paid per unit) and keep detailed records of the date, amount, and price paid for each cryptocurrency purchase.
Then when selling or disposing of cryptocurrency, use the highest cost basis first. The HIFO method means you sell the cryptocurrency units with the highest cost basis first, regardless of when they were purchased. This results in the lowest possible capital gains tax liability, as it maximizes the cost basis used against the sale proceeds.
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What are the advantages of HIFO in crypto tax reporting?
The key drivers for a crypto company to choose highest in first out are the ability to minimize its capital gains tax burden, optimize its overall tax strategy, and ensure compliance with any jurisdiction-specific requirements for cryptocurrency cost basis reporting.
Minimizing capital gains taxes: HIFO allows the company to sell the cryptocurrency assets with the highest cost basis first, resulting in the lowest possible capital gains tax liability compared to other methods like FIFO or LIFO. This can be particularly advantageous during volatile crypto market conditions where the highest priced assets may have been purchased more recently
Optimizing tax bill strategy: HIFO gives the crypto company more control over its tax situation by allowing it to selectively sell the highest cost basis assets. This flexibility can be useful for managing short-term vs. long-term capital gains rates, offsetting losses, and other tax bill planning strategies.
Compliance with regulations: While FIFO and LIFO are more widely recognized cost basis methods, HIFO may be the only allowed method in certain jurisdictions for cryptocurrency tax reporting. Adopting HIFO ensures the crypto company remains compliant with the specific rules and regulations around cost basis calculations in its operating regions.
What’s an example of how HIFO is used?
Let's consider an organization that acquired the following digital assets in 2022 with the given cost basis:
2 BTC at $20,000 in January
5 BTC at $15,000 in May
3 BTC at $30,000 in October
1 BTC at $25,000 in November
2 BTC at $35,000 in December
Sorting these assets in descending order based on their cost basis, without considering the dates, we get:
2 BTC at $35,000
3 BTC at $30,000
1 BTC at $25,000
2 BTC at $20,000
5 BTC at $15,000
Assuming a current Bitcoin price of $25,000, selling 7 BTC from the organization's balance sheet would result in a capital loss of $30,000.
When compared with other cost basis, you would realize:
$60,000 capital gains with FIFO
$25,000 capital losses with LIFO
No gains or losses with ACB
Based on the above example, HIFO could be the most efficient approach for Web3 organizations to minimize their capital gains or maximize losses through offering a higher cost basis.
Read more about all cost basis accounting methods in our recent deep dive.
Are there any jurisdictions where HIFO is encouraged or discouraged?
A team’s ability to use HIFO can vary by jurisdiction, and is encouraged and discouraged accordingly. Our advice is to check with local tax professionals on the accepted cost basis methods in that particular region and the implication of local tax rates.
How can I begin using HIFO?
Integral's crypto accounting software provides HIFO cost basis support for all customers. Recording tax lots manually is almost impossible given the speed web3 teams operate at. Once the method is selected, organizations can generate and export their comprehensive Cost Basis Report automatically. Integral also provides a range of compliant and detailed reports, including closing positions, realized gains and losses, and profit & loss statements.
Take control of your digital assets with Integral – enterprise-grade accounting and crypto tax software that puts you in control.
Frequently Asked Questions
What is HIFO and how does it differ from FIFO and LIFO in crypto accounting?
HIFO, or Highest In, First Out, is a cost basis method for calculating capital gains in crypto transactions by selling the highest priced assets first, which can minimize taxable gains. Unlike FIFO (First In, First Out), which sells the oldest assets first, or LIFO (Last In, First Out), which sells the newest assets first, HIFO focuses on the price of assets to reduce tax liability.
How can I calculate HIFO for my cryptocurrency investments?
To calculate HIFO for cryptocurrency, you need to track the purchase date, amount, and cost basis (price paid) for each asset. When selling, prioritize the disposal of assets with the highest cost basis first, regardless of their acquisition date. This approach aims to maximize the cost basis used against sale proceeds, minimizing capital gains tax. Or use Integral's built-in support for automatically calculating HIFO.
Are there any specific advantages to using HIFO for crypto tax reporting?
Yes, HIFO can significantly lower your capital gains tax by allowing you to sell the most expensive assets first, reducing your taxable gains. This method can be particularly advantageous in volatile markets. Additionally, it provides flexibility in tax planning and ensures compliance with regulations in certain jurisdictions where HIFO is the preferred or required method for crypto cost basis calculations.
