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How HIFO accounting reduces IRS bill

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BitcoinIt is now down 36% from November’s all-time high, but there are some good things about the drop. This is due to an anomaly in the tax code, which helps crypto owners protect their winnings from IRS.

The IRS considers cryptocurrencies property. That means you can spend on, trade, or sell tokens and you are logging a taxable event. The cost basis is what you paid to buy your cryptocurrency, while the market price at the time it was purchased will be the difference. Capital gains taxes can be triggered by this difference.

But a little-known accounting method known as HIFO — short for highest in, first out — can significantly slash an investor’s tax obligation.

You can choose which unit to sell when you’re selling your crypto. Crypto holders can choose the most valuable bitcoin that they have purchased and then use this number to calculate their tax obligations. You will pay less tax if you sell on a higher price basis.

However, it is up to the taxpayer to track everything. Therefore thorough bookkeeping and accounting are essential. Calculations to the IRS cannot be supported if there aren’t detailed records about taxpayer transactions and costs.

Shehan Chandrasekera a CPA is the head of tax strategy for crypto tax software firm CoinTracker.io. It is a very simple way to do accounting. It’s not that they don’t realize it exists.”

The secret to HIFO accounting involves keeping precise details of each crypto transaction for every coin that you have, from when it was purchased and how much it cost, through when it was sold and its market value.

However, if transaction records are not logged properly or the software isn’t up to par, the accounting system defaults into FIFO (first in, first out).

“It’s not ideal,” Chandrasekera explains.

FIFO accounting rules state that you must sell the oldest purchased token when selling your tokens. A lower cost basis may mean that you pay more capital gains tax if your cryptocurrency was purchased before the 2021 crypto bubble.

There’s also the wash sale rule

Experts tell CNBC that combining HIFO accounting and the wash sale rule could save taxpayers more money.

Because the IRS classifies digital currencies like bitcoin as property, losses on crypto holdings are treated differently than losses on stocks and mutual funds, according to Onramp Invest CEO Tyrone Ross. In particular, wash sale rules don’t apply, meaning that you can sell your bitcoin and buy it right back, whereas with a stock, you would have to wait 30 days to buy it back.

This tax code nuance opens the door to aggressive behavior tax-loss harvestingThis is where bitcoin investors buy it back at a higher price and sell it at a loss. These losses may lower your tax bill, or can be used as a way to offset future profits.

Let’s say, for example, that a taxpayer buys one bitcoin at $10,000 and then sells it to a buyer for $50,000. An individual with $40,000 of capital gains would be subject to tax. However, if the same taxpayer has previously suffered losses of $40,000 on previous crypto transactions they would be eligible to offset their tax.

Chandrasekera stated, “You want your appearance to be as low as you can.”

Chandrasekera states that people are doing it on a weekly or quarterly basis depending on their level of sophistication.

Another key aspect of this equation is buying the cryptocurrencys back quickly. If done correctly, investors can buy the dip to get back on the train if the price for the cryptos goes up.

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