Crypto Tax Calculations
Here's what we wrote about crypto previously - https://www.mooresrowland.tax/?s=crypto
In 2014, the IRS issued Notice 2014-21, 2014-16 I.R.B. 938 PDF, explaining that virtual currency is treated as property for Federal income tax purposes and providing examples of how longstanding tax principles applicable to transactions involving property apply to virtual currency. The frequently asked questions (“FAQs”) expand upon the examples provided in Notice 2014-21 and apply those same longstanding tax principles to additional situations. - https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
Official Revenue Ruling: 2019-24 legitimizes many of the assumptions that were previously being made by leading crypto tax companies and tax professionals in the industry. The guidance also provides clarity on some of the gray areas within the world of cryptocurrency including the tax treatment of forks & airdrops, allowable cost basis methods, and rulings around cryptocurrency transfers. https://www.irs.gov/pub/irs-drop/rr-19-24.pdf
Whenever you incur a taxable event from your crypto investing activity, you incur a tax reporting requirement.
A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:
- Trading crypto to fiat currency like the US dollar
- Trading one crypto for another cryptocurrency
- Spending crypto to purchase goods or services
- Earning crypto as income
Prior to the 2019 guide mentioned above, it wasn’t explicitly clear which costing method you were supposed to use when calculating your cryptocurrency capital gains and losses for your tax reporting. Because of this uncertainty, the majority of traders in the past used FIFO (first-in first-out) as this was deemed to be the most conservative approach. The new 2019 guidance officially declares that specific identification methods like LIFO (last-in first-out) or HIFO (highest-in first-out) can be used provided that you can specifically identify particular units of cryptocurrency. This is a very good thing for cryptocurrency traders, and it provides them with a great tax saving opportunity.
According to the IRS guidance, you can specifically identify a unit of cryptocurrency if you have records containing the following information:
- The date and time each 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, exchanged, or otherwise disposed of, and
- The fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit
How does FIFO, LIFO, and HIFO work?
FIFO (first-in first-out), LIFO (last-in first-out), and HIFO (highest-in first-out) are simply different methods used to calculate cryptocurrency gains and losses. From an accounting standpoint, each method “sells” specific assets in a different chronological order which ultimately leads to a different total capital gains or loss numbers on paper.
Using first-in-first-out works exactly how it sounds. The first coin that you purchase (chronologically) is the first coin that is counted for a sale.
LIFO works exactly opposite of FIFO. Instead of selling off the first coins you acquired, you sell the last coins that came in (i.e. the most recent coins you acquired).
Highest-in first-out (HIFO) works exactly how it sounds. You sell the coins with the highest cost basis (original purchase price) first.
HIFO can be used as a “tax minimization” method as it will lead to the lowest capital gains and the largest capital losses, best of both worlds. Keep in mind, net capital losses can be used to offset other income up to $3,000 dollars (the remaining will be carried forward to future tax years).