Learning about Accounting methods can be boring, but not when it comes to an impact to your tax bills of tens of thousands of dollars. Let me cut the chase here and take you to Accounting 101 to explain to you exactly how various accounting methods would determine your tax savings.
First In First out method is reliable and practical, it is as simple as cooking the first lot of eggs you bought from the supermarket as the expiration date nears, basically what you buy first gets sold first. FIFO method has a great benefit when holding periods are longer with potential qualifications for long term capital gains 0%, 15% and 20%. But using this method may have raised a lot of tax bills for crypto traders in the last couple of years as many traders held higher amounts of crypto at year-end, held at higher cost-basis.
Enter specific identification…
Specific Identification For the first time, the IRS has clarified the preferable method of calculation for cryptocurrency, advising to use the “specific identification” method. This means identifying the exact unspent output crypto transaction you have sold out of all the crypto you had in your wallets, and then calculating your tax liability based on the sale of the actual crypto-currency. To get a complete and accurate report, taxpayers are encouraged to use the specific identification method. This method is used to track individual units of virtual currency. It is applicable only when individual units can be clearly identified to provide a complete report of crypto-asset movements, including addresses, wallets, exchanges, etc. For e.g., you bought 20 Bitcoins many moons ago at low prices. You bought 30 more Bitcoins between January and June last year at materially higher rates. In July last year, you transferred the 30 Bitcoins purchased last year to a coin exchange. You kept the original 20 in your wallet off-exchange. You adequately identified the 30 newer units for the trading. You used and complied with SI, and this saved you thousands of dollars in capital gains taxes compared to using FIFO.
Consult with a cryptocurrency trade accounting expert at FinSight CPA & Analytics for a more accurate picture of your crypto-trades.
To get a complete and accurate report, taxpayers are encouraged to use the specific identification method.