HIFO (highest in and first out) accounting can reduce the tax liability of an investor. Resultantly, crypto holders will have the option of picking and choosing the specific units they sell. This implies that they can pick the most expensive bitcoin they bought and determine their tax obligation. The less tax you pay on your sale, the higher will be your cost basis because with capital gains your sale price minus your cost basis becomes the equation.
Despite its steep decline from November’s high, bitcoin has a good side as well, thanks to a quirk in the tax code that shields cryptos from taxation. Cryptocurrencies are treated as property by the IRS, so when you spend, exchange or sell them, you record a taxable event.
There’s always a difference between what you paid for your crypto and what the market value is at the time you spend it. That difference triggers capital gains taxes. However, an investor’s tax liability can be slashed by a little-known accounting method called HIFO.
When a firm’s inventories are accounted for by HIFO, first-out are items with the highest cost.
By keeping HIFO inventory, a company can minimize their taxable income since they will realize the highest cost of goods. General accounting practices and guidelines such as GAAP or IFRS do not recognize the use of HIFO.
Understanding Highest In, First Out:
A firm must decide how to account for inventories, and how inventories are accounted for will impact financial statements and figures. For a period of time, companies would probably prefer to use the highest in, first-out (HIFO) inventory method to reduce their taxable income.
Due to the fact that the sold inventory is always the most expensive inventory the company has (regardless of when it was purchased), the company will always record the maximum cost of the goods sold.
This is in contrast to other inventory recognition methods such as last-in, first-out (LIFO), in which the most recently purchased inventory is recorded as used first, or first-in, first-out (FIFO), in which the oldest inventory is recorded as used first.
HIFO is not commonly used and is also not recognized by GAAP as standard accounting practice. LIFO and FIFO are both common and standard inventory accounting methods, but it is LIFO that is part of generally accepted accounting principles (GAAP).
Implications of the Highest In, First Out Rule:
The HIFO method can be used by companies to reduce their taxable income, but there are some implications that need to be taken into account, including:
- A company’s books are likely to be subject to greater scrutiny by auditors because they are not recognized by GAAP, which might lead to a less favorable opinion than a qualified one
- A first-take inventory taken in an inflationary environment may be obsolete in the future
- A lower inventory value would reduce net working capital
- Finally, if the company relies on asset-based loans, lower inventory value will decrease its borrowing power
