Investing in cryptocurrencies can be a lucrative venture, but it also requires a good understanding of the tax implications of your trades. One of the most important concepts to grasp is your crypto assets’ cost basis. Knowing how to calculate your cost basis accurately is crucial for properly documenting your capital gains for tax purposes.
In this article, we’ll cover what cost basis is and why it’s essential to accurate tax reporting. We’ll also explain how using a crypto tax tool such as Accointing can help you calculate your crypto cost basis
What is Crypto Cost Basis?
Cost basis is the price of a crypto asset at the point when you first acquired it, either through purchase, gift, or airdrop. Keeping track of your crypto cost basis allows you to determine the profit or loss when trading or selling the asset.
Cost basis calculations should include transaction fees and commissions to ensure that the taxable gains are accurately reflected and documented for tax purposes. Given the highly volatile nature of virtual currencies, accurately calculating crypto cost basis is crucial for successful trading and compliance with tax laws. Platforms like Accointing can help investors track their crypto transactions and generate accurate cost-basis records and tax forms.
IRS Guidance on Calculating the Cost Basis for Crypto
The Internal Revenue Service (IRS) has provided guidance on calculating the cost basis for crypto assets. The IRS requires form investors t okeep track of the cost basis for each transaction, including the acquisition date, the acquisition cost, and any associated fees.
If you received the crypto asset as a gift or for free, the cost basis is generally the asset’s fair market value at the time of acquisition. For more detailed information on calculating the cost basis, investors should refer to Publication 551, Basis of Assets, provided by the IRS. This publication explains how to calculate the cost basis for various assets, including digital assets.
Challenges in Calculating Crypto Cost Basis
One of the biggest challenges investors face in crypto is accurately calculating their cost basis. Here are some factors contributing to this challenge:
The volatility of crypto markets and fluctuating prices
Unlike traditional assets such as stocks and bonds, the value of digital assets can fluctuate rapidly, sometimes changing significantly within a few hours or days. This volatility of crypto markets can make it difficult to determine the value of a particular asset at any given time, making it challenging to calculate the cost basis accurately.
Difficulty in keeping track of multiple transactions
Crypto’s interoperability allows investors to buy, sell and transfer multiple assets across different exchanges. Keeping track of all these transactions can be overwhelming. Without accurate records of every transaction, calculating the cost basis accurately is a challenge. Moreover, many crypto exchanges do not provide complete records of transactions, making it necessary for investors to track and record every trade manually.
Importance of accurate record-keeping
Accurate record-keeping is highly important in calculating the cost basis of any given investment. You must keep accurate records of every transaction, including the date and time of the trade, the asset purchased or sold, the price paid or received, and any fees or commissions charged. Any errors or omissions in these records can lead to inaccurate cost basis calculations, which can have significant tax implications.
How is Crypto Cost Basis Calculated?
The cost basis is the total cost of acquiring a crypto asset, including transaction fees and commissions. If you purchased the asset, your cost basis will consist of the purchase price plus any fees.
If the asset was received as a gift or airdropped, the cost basis will be its fair market value at the time you received it. When calculating your cost basis, several methods, such as HIFO, LIFO, and FIFO can be used, depending on your tax situation.
FIFO cost basis method
FIFO is the most commonly used method and stands for “first in, first out.” Under this method, the first asset purchased is the first asset sold. This means that investors can take advantage of long-term Capital Gains Tax rates, which are much lower than short-term rates. However, as long-held assets have typically seen the greatest appreciation in value, FIFO can often result in higher taxes due to larger capital gains. While FIFO is straightforward and easy to understand, it’s not one of the most tax-efficient methods.
LIFO cost basis method
LIFO stands for “last in, first out.” Under this method, the most recently acquired assets are sold first. This means that investors can realize losses on the most recent purchases, which can help offset gains on earlier purchases. This is beneficial in cases where more recent acquisitions have not appreciated in value as much as earlier ones. However, you may be subject to higher short-term Capital Gains Tax rates with this method.
HIFO cost basis method
HIFO stands for “highest in, first out” and this is a more complex method than FIFO and LIFO. Under this approach, it doesn’t matter when an asset was purchased. The highest price paid for a given asset is the cost basis used when sold. This method has many benefits for investors, as the larger the cost basis, the lower the capital gain and, therefore, a lower tax amount.
Examples of using each cost basis accounting method
Let’s assume that an investor purchases 5 BTC over time, with the following prices and dates of purchase:
– January 1, 2021: 1 BTC for $10,000
– February 1, 2021: 1 BTC for $12,000
– March 1, 2021: 1 BTC for $9,000
– April 1, 2021: 1 BTC for $15,000
– May 1, 2021: 1 BTC for $18,000
The investor sells 3 BTC on September 1, 2021, each for $20,000 for a total of $60,000
Under FIFO, the investor will sell the first three BTC purchased: those bought on January 1, February 1, and March 1. The cost basis will be calculated by adding the purchase prices of those three units as follows:
– Cost basis = ($10,000 + $12,000 + $9,000) = $31,000.
The profit realized on the sale will be:
– Profit = $60,000 – $31,000 = $29,000
Under LIFO, the investor will sell the three most recently purchased units: those bought on March 1, April 1, and May 1. The cost basis will be calculated by adding the purchase prices of those three units as follows:
– Cost basis = ($9,000 + $15,000 + $18,000) = $42,000.
The profit realized on the sale will be:
– Profit = $60,000 – $42,000 = $18,000
Under HIFO, the investor will use the three highest-cost Bitcoins as follows:
– Cost basis = ($18,000 + $15,000 + $12,000) = $45,000
The profit realized on the sale will be:
– Profit = $60,000 – $45,000 = $15,000
As you can see, each cost basis accounting method results in a different profit and tax liability for the investor. It’s important to understand the pros and cons of each method and choose the one that works best for your specific situation.
Cost Basis for Crypto-to-Crypto Transactions
The cost basis for crypto-to-crypto transactions is calculated using the fair market value of the crypto asset at the time of the trade. This means that if an investor trades Bitcoin for Ethereum, for example, the cost basis of the Ethereum would be the fair market value of Bitcoin at the time of the trade. The fair market value is the price that the asset would sell for on the open market, and it can fluctuate rapidly for cryptocurrencies. To accurately calculate the cost basis for crypto-to-crypto transactions, investors must keep detailed records of each trade, including the assets’ date, time, and fair market value. This can be a time-consuming and tedious process, especially for investors who frequently trade cryptocurrencies.
However, there are tools available to simplify the process. Accointing, for example, automatically calculates the cost basis for all crypto-to-crypto transactions. The platform integrates with popular cryptocurrency exchanges and wallets, allowing users to import their transaction history and generate accurate tax reports. This can save investors significant time and hassle and minimize the risk of errors or discrepancies in tax reporting.
Crypto Cost Basis for Airdrops & Forks
In addition to buying and selling crypto assets, investors may receive tokens through airdrops or forks. Airdrops refer to the distribution of tokens or coins directly into the wallets of eligible recipients at no cost. This method is often used as a marketing strategy by companies and projects in the crypto space to distribute free tokens or coins to targeted users. However, to qualify for the airdrop, recipients usually need to meet certain criteria or perform specific actions. On the other hand, forks occur when a blockchain splits into two separate chains, creating new tokens for users.
When taxpayers sell the airdropped or hard-forked tokens, it can trigger a capital gain or loss. The calculation of capital gains or losses is based on the difference between the cryptocurrency’s fair market value at the time of receipt and the time of sale. It’s worth noting that there is no double taxation on an asset, and taxpayers are only taxed on the value of the assets received at the time of receipt and the change in value when sold.
Cost Basis for Crypto Gifts
Under current tax law, you can gift up to $16,000 per person per year without paying any gift tax. If you file jointly with your spouse, you can exclude up to $32,000. However, if you gift more than this amount to a single recipient, you will have to file a Gift Tax Return, and your taxable gifts will be subject to an amount from 18% to 40%. The cost basis of the gift to the recipient depends on whether you have a gain or loss. If there is a gain, the tax basis is the same as the donor’s basis, but if there is a capital loss, the tax basis is the fair market value of the cryptocurrency at the time of the gift. If the donor owes any gift tax, this should also be included in the tax basis.
It’s important to note that any gifts received are not taxable income. However, if the recipient decides to dispose of the crypto gift, they will be subject to capital gains tax on any gain.
Let’s look at some examples to understand better how this works:
Tina gives Larry $14,000 worth of BTC as a gift. Since this is less than the exclusion amount of $16,000, Tina does not have to pay gift tax. Tina also does not have to pay any capital gains tax, and Larry does not have to pay any income tax. If Larry decides to sell the BTC, he will be subject to capital gains tax.
Bob and Karen are married and file jointly. They gift John $30,000 worth of BTC. Since they file jointly, their exclusion is $32,000 per donee, and they do not have to pay gift tax.
Bob and Karen gift John $50,000 worth of BTC. In this case, the gift is considered taxable, and while it is still free of capital gains tax and does not have to be reported in their income tax return, Bob and Karen must file a gift tax return and pay tax on this gift. Any amount of tax paid can be added to John’s basis in the BTC.
Benefits of Using Accointing for Crypto Cost Basis
Accointing is a powerful tool for investors looking to accurately calculate the cost basis of their cryptocurrency investments. Here are some benefits of using Accointing:
- Easy to use: Accointing’s user-friendly interface makes it easy for users to track their crypto transactions and generate accurate tax forms. You don’t need to be a tax expert to use it.
- Integration with Multiple Exchanges and Wallets: With 400+ blazing fast integrations across exchanges, wallets, blockchains, and services, including Binance, Coinbase, Kraken, and more. You can connect your accounts to Accointing and automatically import all your transactions, eliminating the need to enter each transaction manually.
- Detailed reports: Our platform generates fully compliant Crypto Tax Reports that include a summary of all your Long and Short-term capital gains/losses and taxable income. Additionally, you will find supplementary files such as Form 8949 in both PDF and CSV formats to assist you in completing your Form 8949, gains, and losses CSV files, a daily balance report, and import files for tax tools such as TurboTax.
At Accointing, users can use their preferred method, as the platform supports them all.
- First-in-Class Crypto Portfolio Tracking & Insights Tool: Take control of your crypto data with our crypto portfolio tracking and insights tool. With Accointing’s portfolio dashboard, you can deep-dive into their transactions and see your entire crypto portfolio at a glance. The dashboard summarizes your buy and sell dates, net profit, and overall gains, allowing you to track it all in real time. This makes it easy to stay up-to-date with your investments and make informed decisions.
- Accurate Crypto Tax Calculator: Accointing’s advanced algorithm to calculate the cost basis of each crypto transaction will ensure investors that their capital gains are accurately reflected and documented for taxation purposes.
- Additional Tax Tools: We offer a Trading Tax Optimizer Tool, which predicts the tax implications of your trades before you execute them, allowing you to meet your tax goals. Also, our Tax Loss Harvesting Tool will identify unrealized losses in your portfolio for you to sell the assets and offset your capital gains.
- Professional Tax Help: You can also connect with a tax professional deeply experienced with cryptocurrency and the Accointing software. Our trusted professionals can help you calculate your crypto gains and taxable income, prepare your US tax return from start to finish, unlock tax saving strategies and minimize your bill, and respond to an IRS audit or secure an IRS payment plan if you can’t pay your bill.
- Dedicated Customer Support: Accointing offers dedicated customer support to help you with issues or questions about the platform or their crypto taxes. You can contact the support team via email, live chat, or the help center and expect a prompt response.
Step-by-Step Guide for Calculating Crypto Cost Basis with Accointing
The first step is to sign up for the Accointing platform. You can enter your email address or login directly through your Apple or Google account. Even if you don’t need to calculate your crypto taxes right away, we recommend signing up for the free plan. It allows you to track your crypto investments across our web and mobile apps and provides valuable insights into your portfolio.
Once you’ve signed up, the next step is to connect all of your wallets and exchanges. To add a wallet, go to the wallet tab and click “add new.” Choose the wallet you want to add, such as Metal Mask, and connect it through the wallet address. Using the wallet address ensures that the information is pulled directly from the blockchain, saving you time and ensuring accuracy.
After importing your transactions, reviewing your crypto portfolio to ensure accuracy and optimize your taxes is important. Accointing makes this easy with a step-by-step review process that walks you through each transaction and prompts you to correct any errors. You can also edit transaction details manually if needed.
Only if you calculate the cost basis of your crypto investments correctly, your capital gains will be reflected and documented accurately and you won’t overpay on your taxes. Accointing’s crypto tax calculator and portfolio tracking platform is the perfect all-in-one solution to help you confidently manage your crypto investments. Sign up for Accointing for free and take your crypto investments to the next level.
The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute financial, investment, legal or tax advice. The present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor.