(Art Credit: Karen Fischer)

It Can Save You Significant Tax Dollars

If you are holding bitcoin in your virtual currency portfolio, you need to be aware of the HIFO (highest in, first out) tax loophole which could save you significant amounts of cash by reducing your tax burden on cryptocurrency capital gains.

Here Is How HIFO Works for Bitcoin and Other Virtual Currency Investments:

As you may be aware, when you sell cryptocurrency, you can select the specific unit you are selling. In this scenario, the strategy is to use the value of the most expensive bitcoin you must determine your tax obligation for any capital gains you have.

This higher cost basis for your bitcoin means that you will pay less tax on your sale, given that capital gains are equal to your sales price minus the cost basis.

Even with the current decrease in the value of bitcoin, this HIFO tax hack will save you from having to pay more capital gains taxes than necessary. The key point is that the IRS treats cryptocurrencies like property, so each time you spend, exchange, or sell tokens, you are creating a taxable event. The difference between how much you paid for your crypto (the cost basis) and the market value at the time you sell it is what any capital gains tax is based on.

Use the HIFO Rule to Reduce Cryptocurrency Capital Gains

HIFO can significantly reduce your cryptocurrency capital gains tax obligation when you choose the highest value specific unit of bitcoin or other cryptocurrency you are selling to calculate your tax obligation. Obviously, a higher cost basis translates into less tax that you must pay on your sale of bitcoin or other virtual currency.

To take advantage of this loophole legitimately, you need to keep track of all your cryptocurrency sales and purchases in detail including the date and transactional specifics as well as the cost basis plus all of your calculations in case they need to be substantiated to the IRS.

Why Would You Want to Use HIFO and Not FIFO for Cryptocurrency Accounting?

In contrast to HIFO, FIFO (First In First Out) accounting rules mean that when you sell your tokens, you’re selling the earliest purchased coin, which may not be the highest priced one. In fact, if this is the case and you bought crypto before the sharp increases in price we see now, your spread between the lower purchase price and any potential gains by selling is much larger…which also magnifies the taxes you need to pay on it.

The IRS classifies digital currencies as property, therefore losses on crypto holdings are treated differently than losses on stocks and mutual funds. For example, unlike stocks, you can sell your bitcoin and buy it right back. In the same scenario with stocks, you would need to wait 30 days for the buyback. Clearly, the opportunity exists for investors to sell at a loss and buy back Bitcoin at a lower price, lowering their tax bill now or in the future.

How to Take Advantage of HIFO Right Now

If you purchased bitcoin or other virtual currencies when the market was low and you can now sell at a significantly higher price, if you act quickly and buy while the price remains low, you will not only reduce your capital gains exposure but also be able to purchase more currency at a lower cost with the expectation that it may increase in value again.

Be Forewarned About Forward Looking Statements

Please be aware that HIFO is one suggestion for lowering your tax bill and you should consider your own risk tolerance and financial situation carefully. There are no guarantees on the future performance of any investment vehicle and crypto is an even more nebulous entity for investors and analysts to predict. While cryptocurrency (crypto) investors were expected to meet the same reporting standards when it came to paying tax and reporting profits and losses to the Internal Revenue Service, the passage of the Infrastructure Investments and Jobs Act (IIJA) shows that the IRS is serious about enforcing, strengthening, and standardizing these requirements. This means that whenever you deal with crypto, you need to track and record the activities carefully. You can find the reporting requirements stated in section 80603 of the Infrastructure Investments and Jobs Act (IIJA).