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When it comes to crypto accounting, LIFO (Last-in, First-out) is an attractive accounting method for crypto investors in volatile markets, helping you reduce your tax profile in the short term. However, in a market as volatile as crypto, one must not forget that what works on paper doesn’t always work in practice. In this post, we will talk about everything you need to know about LIFO: what it is, when it works, when it doesn’t, and how choosing the wrong accounting method can have lasting consequences.
What is LIFO (Last-In, First-Out)?
LIFO, or Last-in, First-out, is a tax accounting method that operates on the assumption that the most recently acquired asset is the first asset that is sold or dispensed. It is a tax accounting method favored by accountants in jurisdictions where crypto assets are viewed as property, such as the United States.
How does LIFO work?
The best way to show LIFO in action is with an example. In our example, John purchases 1 BTC on 1st January for $25,000 and on 1st February for $45,000. On March 1st, John sold 1 BTC for $60,000. Under LIFO, we will assume that the BTC he purchased on 1st February is the first to leave his wallet.
In that case, when we calculate the capital gain for the sale of 1 BTC on 1st March, the cost basis would be the price of 1 BTC on 1st February. We can find the capital gain of the sale by subtracting the selling price from the cost basis. In this situation, the capital gain would be $15,000.
When should you use LIFO?
In general, LIFO is the most beneficial accounting method in a bull market where the prices of assets are on the rise. This will allow you to sell your newest asset for a profit while exposing only a small portion to capital gains tax as opposed to FIFO, where it is first-in, first-out. Also note that LIFO is the crypto accounting method that is widely accepted in the United States.
When should you not use LIFO?
LIFO can be particularly disadvantageous in bear markets when prices drop. In such a situation, you will expose yourself to higher capital gains tax. It is also not suitable if you are investing for long-term gains and if you do not have detailed records of your transactions. Also note that LIFO may not be suitable when investing outside the United States. This is because LIFO is not universally accepted, and its use can lead to distorted financial statements and expose you to fines and penalties.
Conclusion
LIFO (Last-in, First-out) is an extremely popular accounting method that has made its way into crypto transactions. While adopting this method offers a range of benefits, there are also situations where it can have a negative impact on your digital assets and tax compliance. If you want to make the most of your assets while remaining compliant with all the rules and regulations, you will need the help of a professional and talented crypto CPA.
At Onchain Accounting, we’ve been helping investors and businesses with all their crypto accounting needs for almost a decade. Our team of skilled professionals will work tirelessly to make sure you are always on top of your crypto accounting needs. Your journey to clean bookkeeping and smoother transactions starts with us. Contact us today and see what we have to offer.
