Cryptocurrency Accounting Methods
Cryptocurrencies are getting more popular day by day, and handling crypto accounting is becoming more complex for new users. When you trade or sell cryptocurrency, any profit you earn is a capital gain, while selling it for less than you paid is a capital loss, and it may help lower your tax. The price at which you actually paid for it is your cost basis. The regulator allows you to choose which coins you sold using different methods like FIFO, LIFO, or HIFO, and each one can affect how much tax you owe. If you do not keep clear records, the regulator assumes you are using FIFO. But if you track your crypto properly, using LIFO or HIFO might lower your taxes, depending on how much your crypto has gone up and what your financial goals are.
What is FIFO, LIFO and HIFO Crypto Accounting Methods?
There are different methods used for cryptocurrency accounting in UAE and globally. These methods help you determine which coins should be considered sold first:
- FIFO stands for (First In, First Out)
- LIFO stands for (Last In, First Out)
- HIFO stands for (Highest In, First Out)
No matter which method you use, the regulators want you to keep on working using the same method for the whole tax year. You can choose a different method each year, but if you are not using FIFO, you must have clear records to prove it.
What is FIFO and How It Works?
FIFO is a simple accounting method where the coins you buy first are the ones you sell or use first. For example, if you purchased 1 Bitcoin at the price $20,000 in January and another at the price $30,000 in March. After some time, you sold 1 Bitcoin in July for $35,000, FIFO considers the $20,000 Bitcoin as the one sold. This means your taxable gain would be $15,000.
What Makes FIFO a Good Option to Use?
FIFO is simple to use because you don’t need to show exactly which crypto coins you sold. It is easy to understand and apply, especially for tracking crypto or inventory. It works well for people who don’t trade often.
What is LIFO and How It Works?
LIFO is an accounting method where the coins that you bought recently are the ones you sell first. For example, if you purchased 1 Bitcoin at the price of $20,000 in January and then you bought another at the price of $30,000 in March. After some time, you sold 1 Bitcoin in July for $35,000, LIFO considers the $30,000 Bitcoin as the one sold. This means your taxable gain would be $5,000.
Is LIFO Better than FIFO?
It depends on the market. If prices are rising, LIFO can help you pay less tax by selling the newer, more expensive coins first. But if prices are falling or you want quick profit, FIFO might be better. It all depends on what you want and how you understand the market conditions.
What is HIFO and How It Works?
HIFO is a crypto accounting method where the coins you bought at the highest price are the ones you sell first. For example, if you purchased 1 Bitcoin at $20,000, another at $25,000, and another at $30,000. After some time, you sold 1 Bitcoin for $35,000, HIFO considers the $30,000 Bitcoin as the one sold. This means your taxable gain would be only $5,000.
How to Calculate Crypto Value Using Average Cost?
The average cost method in crypto accounting is a simple way to track how much you paid for your cryptocurrency. You add up the total amount spent on a coin and divide it by how many units you own. This gives you an average price per coin. It’s used to calculate profits when you sell. This method is common in countries like Canada and the UK.
What is the Most Effective Cost Basis Method?
There is no method that 100% works perfectly for everyone. Some people choose FIFO because it is easy to use, while others go with LIFO or HIFO to try and lower their gains, especially when crypto prices are rising. Picking the right method depends on a few things, like whether you think prices will go up, how you plan to use your crypto, and if you expect any big changes in your income or tax situation in the future.
Key Takeaways
It is significant for you to choose a suitable crypto accounting method to manage your taxes as well as understand your profits. It depends on you and your needs which method (FIFO, LIFO, HIFO) is suitable for you. Each method has its own advantages and disadvantages, so you must choose depending on your needs. When you are in doubt, consider speaking with a crypto tax expert to stay compliant and save money.
