Let’s say you purchased one Bitcoin 14 months ago for $15,000 and another Bitcoin 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 ($60,000 – $15,000), or
$20,000 ($60,000 – 40,000)?
It depends on your crypto accounting method.
It’s up to you to choose the method you use to calculate crypto gains and losses. At a time of surgingcryptocurrency prices, the method you use can have a big impact on the amount of your taxable gains.
FIFO: The Default Method
FIFO (first in, first out) is the default method of crypto accounting. It must be used if you don’t specify anothermethod.
With this method, crypto units are deemed to have been sold, exchanged, or otherwise disposed of inchronological order beginning with the earliest unit you purchased or acquired—that is, on a first-in, first-out basis.
Example.
You bought one Bitcoin on January 1, 2022, for $15,000. You bought another Bitcoin on January 1,2023, for $25,000. You bought another Bitcoin on March 1, 2023, for $40,000. On January 1, 2024, you sold oneBitcoin for $60,000.
Using the FIFO method, your cost basis for the sale is $15,000 since that was the cost of the first Bitcoin youacquired. You have a capital gain of $45,000 ($60,000 – $15,000). This is a long-term capital gain since the cryptodeemed sold was held for more than one year.
Since it’s a long-term capital gain, your maximum tax rate is 20 percent—23.8 percent if the net investment incometax (NIIT) applies—compared with up to 37 percent for ordinary income (40.3 percent if the NIIT applies).
FIFO is a conservative, IRS-approved method. The IRS will never complain if you use it. FIFO is also simple to use—since the oldest crypto units are sold first, you just take the purchase date and price to determine cost basis.
FIFO can also maximize long-term capital gains because selling the oldest unit first makes it easier to satisfy theone-year holding period.
Another advantage of FIFO is that currently it can be applied universally to all the crypto units a taxpayer owns,regardless of the number of wallets or exchanges in which they are held. In other words, FIFO need not be appliedto each wallet or exchange separately.
Such universal pooling of digital assets makes FIFO easier to apply than specific identification. But proposed IRSregulations that have yet to take effect prohibit universal pooling (as we discuss below).
On the other hand, FIFO is an inflexible method that does not always result in the lowest cost basis for digitalassets, which could lead to higher capital gains taxes. This is particularly likely in a rising market since you’ll beselling the oldest crypto with what is often the smallest cost basis.
Specific Identification Method
Instead of FIFO, you can use the specific identification method of accounting.
Specific identification permitstaxpayers to identify which crypto units are being sold in a particular transaction.
But it can be difficult or impossible for crypto owners to identify specific digital assets before a trade. Mostcentralized crypto exchanges don’t provide a notification mechanism to support specific identification. Likewise,unhosted digital wallets lack mechanisms for users to specify which digital assets to sell before a transactionoccurs.
The workaround is for crypto owners to use accounting methods that, like FIFO, calculate crypto basis, gains, andlosses after the trade. The most widely used methods are HIFO and LIFO. Technically, these are also specificidentification methods—because any method other than FIFO is a specific identification method.
HIFO.
HIFO is short for “highest in, first out.” With HIFO, you are deemed to sell the crypto units with the highestcost basis first.
Because HIFO sells your crypto with the highest cost basis first, it ordinarily results in the lowest capital gains andthe largest capital losses. But using HIFO can also cause you to lose long-term capital gains treatment, since thehighest-cost units may not have been held for more than one year.
Example.
You bought one Bitcoin on January 1, 2022, for $15,000. You bought another Bitcoin on January 1,2023, for $25,000. You bought another Bitcoin on March 1, 2023, for $40,000. On January 1, 2024, you sold oneBitcoin for $60,000.
Using the HIFO method, your cost basis for the sale is $40,000 since that is the highest-cost Bitcoin you acquired.You have a short-term capital gain of $20,000 ($60,000 – $40,000) that’s taxed at ordinary income rates.
LIFO.
LIFO is short for “last in, first out.” It is the opposite of FIFO: the last crypto units you acquired become thefirst units that you sell.
Example.
You bought one Bitcoin on January 1, 2022, for $15,000. You bought another Bitcoin on January 1,2023, for $25,000. You bought another Bitcoin on January 1, 2023, for $40,000. You bought another Bitcoin onMarch 1, 2023, for $35,000. On January 1, 2024, you sold one Bitcoin for $60,000.
Using the LIFO method, your cost basis for the sale is $35,000 since that is the cost of the last Bitcoin youacquired. You have a short-term capital gain of $25,000 ($60,000 – $35,000).
Requirements to use specific identification.
Using HIFO, LIFO, or other specific identification methods requiresmeticulous record keeping. If you lack adequate records, on audit the IRS will default to the FIFO method, whichcan result in more taxable profit.
Your records must contain
the date and time each crypto unit was acquired,
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.
Specific identification must be implemented on an exchange-by-exchange and wallet-by-wallet basis. You can’tpool all your accounts together as you currently can with FIFO.
Some crypto exchanges allow users to elect specific identification within their platform. However, many don’t. Noris this an option when you use an unhosted wallet to store and trade your crypto. In this event, you must do theproper record keeping yourself.
It’s next to impossible to create these records manually, particularly if you have many trades. Most crypto ownersuse specialized crypto tax software that automates the basis and gain/loss calculations and can even fill out therequired tax forms.
To use the software, you export your crypto transaction histories from each exchange or wallet you use and specifyyour accounting method.
Can You Change Your Crypto Accounting Method?
You can change your crypto accounting method from year to year—for example, you can change from FIFO to aspecific identification method such as HIFO.
Using FIFO or a specific identification method such as HIFO or FIFO to determine the basis of digital assets is nota method of accounting.
Therefore, permission from the IRS is not needed for such changes. Note that your taxreturn doesn’t have to disclose which method you use.
Proposed IRS Regulations
Proposed IRS regulations scheduled to take effect for the 2025 tax year would make major changes in crypto taxaccounting. To use specific identification (including HIFO or LIFO), crypto owners would have to identify each unitto be sold no later than the time of sale. If a crypto owner fails to do so, the FIFO accounting method must beused.
For crypto held in a wallet or account, the taxpayer’s records must timely identify the particular units to be sold orotherwise disposed of. For crypto in the custody of a “digital asset broker” (broadly defined to include exchangesand custodial wallet services), the taxpayer must provide adequate identification to the broker no later than the timeof sale.
As mentioned above, it can be practically impossible for crypto owners to identify specific digital assets before atrade. Moreover, most crypto exchanges don’t provide a notification mechanism to support specific identification.Thus, if the proposed regulation goes into effect as written, it may prevent use of the specific identification methodby many crypto owners.
The proposed regulations also require that FIFO be applied per wallet or account. Universal pooling of digitalassets across all accounts is not allowed.
In addition, starting with the 2026 tax year, digital brokers must file a new IRS Form 1099-DA that reports
the adjusted basis of the digital asset sold,
the date and time the digital asset was purchased, and
whether any gain or loss on the digital asset sold is long-term or short-term.
Brokers are not currently required to file any 1099 forms with the IRS to report crypto trading gains and losses,although some do file Form 1099-K or Form 1099-B.
The IRS’s proposed regulations have met with widespread opposition and could be changed or further delayed.
Takeaways
Here are four takeaways from this article:
FIFO (first in, first out) is the default cost basis method for cryptocurrency, but crypto owners areallowed to use specific identification or a specific identification method such as HIFO or LIFO.
Use of specific identification or a specific identification method such as HIFO or LIFO to calculatecrypto cost basis can minimize gains but requires more record keeping.
Crypto owners should consider using crypto tax software to calculate their cost basis and simplifyrecord keeping.
Crypto cost basis methods such as FIFO and HIFO are not methods of accounting. You don’t need todisclose them on your tax return, and you don’t need IRS permission to change methods from yearto year.
