HIFO vs. FIFO: Which method is better for you?

Traders rely on various accounting methods to differentiate units when the same asset has been purchased multiple times at different prices, helping them assess the value of their unsold investments. Among the more common approaches are HIFO and FIFO.

HIFO (highest-in, first-out) sells the highest-cost assets first, which can minimize capital gains tax by realizing smaller gains or even losses. FIFO (first-in, first-out), by contrast, assumes the oldest assets are sold first, making it simpler to implement but potentially resulting in higher taxable gains, as it often prioritizes selling lower-cost assets.

Under the new Internal Revenue Service regulations, effective Jan. 1, 2025, specific identification (Spec-ID) will be the default method for calculating the basis of digital assets sold, provided the specific asset sold is identified no later than the time of sale. Spec-ID allows taxpayers to match the exact units sold with their purchase records, such as acquisition date and cost. HIFO, as a subset of Spec-ID, will still be permitted, but it must be preset as the chosen method before the sale. If no Spec-ID is made, FIFO will automatically apply.

While these changes apply to transactions starting in 2025, for the 2024 tax year, it’s still possible to use HIFO retroactively under the current rules.

In this guide, we’ll explain the differences between HIFO versus FIFO, covering how each method works, their advantages and disadvantages, and how to decide which one best fits your investment strategy and tax needs.

What is HIFO? 

The HIFO tax reporting method assumes a trader sells the assets with the highest purchase price first, prioritizing minimizing capital gains over other factors. This approach can help minimize capital gains and maximize capital losses, potentially leading to the lowest possible capital gains tax liability. However, under the new IRS regulations, HIFO must be established before the sale to comply.

To use the HIFO method, a trader must maintain detailed records of inventory purchases, including the acquisition dates and prices. These records are crucial because HIFO involves selling the highest-cost assets first. By matching higher-cost investments against each sale, traders can reduce their reported profits during times of rising prices, which may result in lower tax bills.

HIFO example

To illustrate how HIFO works, consider this example: A trader purchases 10 BTC at $60,000 each in January and another 10 BTC at $62,000 each in February, totaling 20 BTC with a combined cost of $1,220,000. In March, the trader decides to sell 15 BTC, retaining 5 BTC in their portfolio.

Using the HIFO method, the trader accounts for the 15 most expensive BTC first. This means they start with the 10 BTC purchased in February at $62,000 each, totaling $620,000. Next, they include 5 of the BTC bought in January at $60,000 each, adding another $300,000. Therefore, the total cost of the 15 BTC sold amounts to $920,000.

From a tax perspective, reporting a higher cost basis for the BTC sold reduces the declared profit, which can result in a smaller tax bill.

HIFO pros and cons

While HIFO can offer significant tax savings and improve cash flow, it also comes with potential disadvantages, such as reduced profitability and limited recognition under international standards. Here are the key advantages and disadvantages of using HIFO for managing crypto investments:

HIFO advantages

• Tax advantages: HIFO allows traders to sell higher-cost assets first, reducing taxable gains and potentially lowering overall holding costs by retaining to reduce their tax obligations. By strategically selling higher-cost investments first, traders lower their taxable gains, leading to substantial tax savings.
• Better after-tax cash flow: Using HIFO allows traders to sell higher-cost assets first, resulting in a higher cost basis and lower capital gains tax. While the proceeds from each sale remain the same regardless of method, the lower tax from HIFO translates to better after-tax cash flow, leaving more funds available for new investments or acquisitions, ultimately contributing to greater financial flexibility.

HIFO disadvantages

• Tax-adjusted profitability perception: While HIFO can reduce taxable gains and lower tax liability, it may give the appearance of lower profitability on tax-adjusted financial statements. This perceived reduction in profitability could make the company less appealing to investors and lenders who focus on tax-to-book valuations and prefer higher reported profits.
• Must be predetermined: While HIFO, as a subset method of Spec-ID, will remain permitted under new IRS regulations, it must now be established as the chosen method before the sale and cannot be applied retroactively.
• Potential for net capital losses: HIFO can result in net capital losses because selling higher-cost investments doesn't always generate a profit. Although these losses can lower tax obligations, large losses might have to be carried forward to future years, which can delay the benefits of any tax savings.

What is FIFO?

Unlike HIFO, traders more commonly use FIFO as a tax reporting method because it prioritizes selling the oldest investments first, regardless of the tax basis and taxable gain potential. This strategy aligns with other areas of tax law, like inventory and stock sales, and will automatically apply under the new U.S. tax regulations if no Spec-ID is made. FIFO treats the oldest assets as sold first, making it easy to track costs and calculate gains. While it may not always minimize taxes like HIFO can, FIFO is commonly chosen for its simplicity and consistency.

Also, like HIFO, FIFO requires traders to keep detailed inventory records of their holdings, including purchase dates and amounts.

FIFO example

Returning to our Bitcoin example, let’s consider the same inventory scenario: a trader purchases 10 BTC at $60,000 each in January and another 10 at $62,000 in February, resulting in a total of 20 units costing $1,220,000. In March, they sell 15 BTC while retaining five. 

FIFO operates on the principle of selling the oldest BTC first. To account for the 15 sold in March, we take the entire 10 purchased in January for $600,000, plus five from February at $310,000, resulting in a total cost of $910,000. This $10,000 difference compared to the HIFO method means the trader appears to have profited more, leading to a higher tax liability.

FIFO pros and cons

Like HIFO, FIFO offers several potential benefits and drawbacks. Understanding these can help determine whether FIFO is the right choice for managing inventory and financial reporting.

FIFO advantages

• Simplicity: The FIFO method is easy to understand and implement, aligning with the natural flow of inventory by selling older items first while newer ones come in.
• Higher taxable income: FIFO often results in higher taxable income than HIFO because it generally sells lower-cost, older assets first. While FIFO doesn’t affect the portfolio’s market value, higher taxable income may appeal to creditors who consider reported income on tax returns when evaluating loan applications or other forms of credit.
• Compliance: FIFO remains permissible and serves as the default cost-basis method under the new IRS tax regulations if Spec-ID is not used. It aligns with IRS requirements by tracking original purchase dates and costs, simplifying tax reporting for those who opt not to use Spec-ID.

FIFO disadvantages

• Higher tax liability: Unlike HIFO, FIFO can lead to a higher tax burden because it often results in selling older inventory first, which may have appreciated in value compared to newer, higher-cost tokens.

HIFO vs. FIFO: Which is better?

When comparing HIFO and FIFO methods for cryptocurrency accounting, specifically, it's important to understand that neither method is inherently superior. HIFO can provide significant tax benefits by minimizing capital gains, making it particularly advantageous in the volatile crypto market. It also allows investors to strategically realize losses, which can offset gains and potentially reduce overall tax liability. However, under new regulations, HIFO requires careful planning and must be preset to comply. In contrast, FIFO is easier to implement and widely accepted by tax authorities, making it a safer choice for those who prioritize simplicity and regulatory compliance.

Ultimately, the best accounting method depends on factors such as trading frequency, holding duration, investment strategy, and local tax laws. Consulting a tax professional can help you determine the most suitable approach for your cryptocurrency investments.

Navigating crypto taxes with confidence

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.