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Introduction
Today, as usual, we’re diving into the world of crypto taxes. In this blog post, we’ll discuss the critical step of choosing the right tax method when reporting your crypto transactions. This is essential for US investors and some other countries, as it can significantly impact the taxes you owe. So, let’s get started!
Why Using Tax Software Matters
In several previous posts, we’ve explained the benefits of using tax software for crypto reporting. The software streamlines the process of taxes by automatically importing your transaction data via APIs, making life easier for crypto investors. However, technology can be finicky. Having someone to ask questions of when you encounter API issues is always useful!
The Importance of Choosing the Right Tax Method
Once you have your data in and everything reconciled, it’s crucial to choose the right tax method before running your tax reports. A tax method is the way your tax software or brokerage records your cost basis. In the US, there are three common tax methods that satisfy the IRS’ requirement of “specific identification” for your cost basis, and your choice can significantly impact your tax liability.
1. First-In-First-Out (FIFO)
FIFO is the preferred method for the IRS. It means that the first Bitcoin you bought is the first cost basis used and therefore, when you sell Bitcoin, the cost basis is from your initial purchases, no matter how many you’ve bought. This often leads to larger tax bills because, in most cases, your earliest purchases have had time to grow from a lower-cost basis and therefore realize more gains.
2. Highest-In-First-Out (HIFO)
HIFO, on the other hand, uses the cost basis of the most expensive Bitcoin you bought first. If you bought Bitcoin when it was high and sold it when the market was down, you can claim a loss, potentially reducing your tax liability.
3. Last-In-First-Out (LIFO)
LIFO uses the cost basis of the most recent Bitcoin you purchased. Depending on the market, you could realize gains or losses compared to where the market currently is.
Choosing the Right Method
The key is to consider how the market is performing. In bullish years, FIFO may lead to higher tax bills, while HIFO or LIFO can help reduce them. During bearish times, using FIFO may make sense to lock in those earlier, lower-cost bases for future gains.
Consider your financial situation and goals. You can even change your method year-to-year, depending on the market’s performance and your capacity to pay taxes. Some tax software, like the one we use, allows flexibility in choosing methods.
Reporting in Other Countries
Different countries have other tax methods. In Canada, for example, investors use the Adjusted Cost Basis Method, which averages all purchases to determine cost basis. England has its own method as well called His Majesty’s Revenue and Customs. If you are choosing tax software, it’s important to make sure it is capable of handling your country’s method and currency!
Conclusion
Choosing the right tax method is a crucial step in optimizing your crypto taxes. It can significantly impact your tax liability, depending on your financial situation and the market’s performance. Be sure to select the method that aligns with your goals and stay informed about your country’s tax regulations.
If you need assistance or have questions about your crypto taxes, don’t hesitate to reach out. Remember, learning and exploring new strategies in the world of finance can be exciting and rewarding. So keep on learning, and have a great week!
More info about the UK Government’s department, His Majesty’s Revenue and Customs, or HMRC.
Read more about Why you want to use software to do your crypto taxes
Find out more about CoinTracking, our recommended tax software, and what we can offer you here (like 25% off unlimited)
Don’t forget to check out our mini-course on The Crypto Tax Matrix for valuable insights into managing your crypto tax obligations.
Reach out to us for any assistance with your crypto taxes. Book a call here.
Did you read our previous post about crypto taxes titled: “Crypto Taxes Unveiled: How to Navigate the Complex World of Taxation“
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