Inventory refers to the total quantity of a specific type of crypto held by an individual. A person's crypto inventory consists of multiple individual tax lots. Proper management of crypto inventory requires accurate tracking and documentation of all transactions, including acquisitions, dispositions, and transfers. This includes maintaining records of the acquisition date, cost basis, and disposition date for each tax lot held as inventory.
Tax Lot / Inventory Lot / Lot:
A tax lot refers to a specific group of units in a particular investment that were acquired at the same time and for the same cost basis. It is necessary to individually track tax lots in order to properly calculate the tax gain or loss when an asset is disposed of.
The acquisition date is the date on which an individual takes control of an asset. In the United States, the acquisition date is used to determine the holding period of an asset (Long Term or Short Term) for tax purposes. Identifying the true/original acquisition date of assets that are transferred between accounts or wallets can be challenging. Currently, the TaxBit system uses the transfer date as the acquisition date, but this will change as the Cost Basis Interchange (CBI) is more widely adopted, as it will facilitate the exchange of tax lot information during asset transfers.
The cost basis of an asset is generally set at the time of acquisition and represents the value of the asset at that time and/or the amount paid for the asset. The cost basis is used to calculate any gain or loss when the asset is disposed of. For example:
Buy 0.5 BTC for $200
Price per BTC: $400
Cost Basis of the 0.5 BTC: $200
Income of 1.5 BTC with a fair value of $750
Price per BTC: $500
Cost Basis of the 1.5 BTC: $750
Cost Basis Method (or Accounting Method):
The cost basis method is the inventory management method used to determine the cost basis of an asset for tax purposes upon sale. The IRS allows two different methods for calculating and tracking the cost basis of fungible digital assets: FIFO (First-in First-out) and Specific Identification.
- First-in First-out (FIFO):
FIFO is a method for determining cost basis in which the shares or units of an asset that are sold first are assumed to be the ones that were acquired first.
- Specific Identification (Spec Lot ID):
Specific Identification is a method for determining cost basis in which specific lots are identified at the time of sale to calculate gains or losses. The IRS requires more detailed information to support this cost basis method than is required for FIFO.
- Highest-in First-out (HIFO):
HIFO is a method for calculating cost basis in which the shares or units of an asset with the highest cost basis are assumed to be the ones that were sold first. Although HIFO is not recognized as an accounting method by the IRS, it adheres to the IRS rules of Specific Identification. By selling shares with the highest cost basis first, individuals can recognize the lowest possible gains or the highest possible losses, thereby reducing their overall tax liability.
Missing Cost Basis:
Tracking the cost basis and original acquisition date of assets that are transferred between accounts and/or wallets is challenging. As a result, transferred assets generally result in a single tax lot with a "missing cost basis." The correct tax gain or loss cannot be determined for assets with a missing cost basis.