First In, First Out

First In, First Out (FIFO) is a method used to determine the cost-basis for tax calculations in inventory. It is recognized by the IRS and is implemented in various tax jurisdictions worldwide. In the context of cryptocurrency, FIFO considers the first coins purchased as the first coins sold when calculating the cost of goods sold (COGS) and associated tax on profits.

What is the concept of First In, First Out?

First In, First Out (FIFO) is an inventory method recommended by the IRS for U.S. taxpayers who cannot specifically identify a unit of cryptocurrency due to missing or unavailable information. This is also known as the Specific Identification Method (refer to IRS Notice 24).

When you receive or dispose of cryptocurrency, you may be liable for capital gains and income tax based on the type of transaction. If you have engaged in profitable trading or earn interest from your crypto holdings, you are required to pay taxes.

Using the FIFO method, your assets are considered to be sold in the same order as you acquired them. The IRS has classified FIFO and Specific Identification as the recommended methods for calculating cost basis in its latest cryptocurrency tax guidance report, Rev. Rul. 2019-24.

It is important to note that the IRS determines the amount of tax based on the duration of cryptocurrency ownership before selling. There may be long-term capital gain discounts for assets held for more than one year. If you need to report your crypto earnings and do not meet the Specific ID rules, FIFO is the most commonly used inventory method and reflects a conservative accounting approach.

How do you calculate cryptocurrency taxes using FIFO?

According to the IRS, you need to calculate capital gains for each transaction involving cryptocurrency by subtracting the cost basis from the proceeds. The proceeds refer to the amount received, while the cost basis refers to the amount paid to acquire the cryptocurrency. If the transaction involves crypto-crypto exchange, you will need to determine the values in USD. Additionally, any associated fees can be added to the cost basis.

For example, let’s say you purchased one coin in 2015 for $1,000, another in 2017 for $2,000, and sold one in 2020 for $3,000. Using the FIFO method, you would sell the first coin from your inventory acquired in 2015. The capital gain would be $2,000 ($3,000 – $1,000).

It is crucial to keep track of your cryptocurrency transactions and maintain accurate records of the purchase dates and prices. FIFO assumes that the first coins purchased are the first ones sold, which can result in different tax implications compared to other inventory methods like Last In, First Out (LIFO) or Specific Identification.

By using FIFO, you can simplify your tax reporting process and ensure compliance with the IRS regulations. It provides a consistent and reliable method for determining the cost basis of your cryptocurrency holdings.

In summary, FIFO is a widely recognized method for calculating the cost basis of cryptocurrency assets. It is recommended by the IRS and other tax jurisdictions worldwide. By understanding and implementing the FIFO method, you can accurately calculate your capital gains or losses and fulfill your tax obligations as a cryptocurrency investor or trader.

Who is the author?

Shane Brunette is the founder and CEO of CryptoTaxCalculator. Since 2018, he has been collaborating with accountants worldwide to develop tax software that accurately handles cryptocurrency transactions. With over a decade of leadership and software development experience in large enterprises, he holds a master’s degree in artificial intelligence.

Shane has expertise in developing robust apps, designing product roadmaps, and leading successful engineering teams. He has spearheaded the development of a tax software solution for cryptocurrency users, supporting hundreds of exchanges across more than twenty tax regions.

Connect with Shane on LinkedIn.