When it comes to taxes, cryptocurrency has been the source of a lot of uncertainty. Despite the ambiguity of the IRS' current tax guidance, thousands of letters were mailed to crypto traders and investors advising them to pay their tax or face fines and other repercussions. Let's take a look at how the bitcoin cost basis and tax calculator is used; as well as some of the challenges often faced with tracking cost basis—particularly across different wallets and exchanges—as well as how to overcome them.
Calculating Crypto Cost Basis
Cost basis (CB) is defined simply as the total sum you spent to acquire an asset, including purchase price, transaction cost, and brokerage or exchange fees.
Crypto CB Formula:
(Crypto Purchase Price + Fees) / Quantity
A good example might be this, say you've bought $200 of Bitcoin (BTC) at an average coin cost of $20,000. This means that you'd own about .01 BTC based on simple math. However, in most modern transactions, you're going to have exchange fees that correlate to this purchase.
Let's say for this specific scenario your fee was .02%, which is what it would be trading on FTX through limit orders. (See our full crypto exchange fee guide here.)
That would mean you'd have also paid a fee on this transaction of $.04, bringing your total costs up to 200.04 for the .01 bitcoin. This is your cost basis for that quantity of BTC. On a whole coin basis, you would divide $200.04 by .01, brining your 1 BTC cost basis to $20,004 per coin for this transaction.
This equation provides the initial cost basis for when you purchase the crypto. However, this is only a factor in then calculating your total tax burden when you do go to sell.
Particularly, when you do go to sell, which tax calculation method you're using comes into play to calculate your tax burden. Are you using FIFO, LIFO, or HIFO?
HIFO, LIFOM, FIFO
FIFO, known as First in First Out, calculates the cost basis for the purchase of your oldest (first) crypto held in your wallet or exchange against the cost basis of the sale you just made.
LIFO, or Last in First Out, calculates cost basis for the sale as the cost basis of the most recent (last) crypto you acquired.
Finally, HIFO, or Highest in First Out, calculates cost basis for the sale as the cost of the most expensive crypto transaction you purchased first.
Now, if your eyes just glazed over, not to worry. Automated tax software tools like Ledgible handle all of this for you when you set up your account.
Is exchanging one crypto for another taxable?
Yes, changing one cryptocurrency (crypto) to another is generally considered an event for taxation. This is because converting one currency to another might result in a capital gain or loss. When you convert one currency to another, you're essentially selling the first and purchasing the second. As a result, any gains or losses from the transaction will be subject to capital gains tax. However, this problem is more complex, and competent cryptocurrency tax and accounting software like Ledgible can help you minimize your tax burden.
If you're interested in learning more about this topic, you can read our separate post on this scenario here.
Digital Asset Cost Basis Calculation: Airdrops & Forks
A hard fork or an airdrop does not incur any fees because you are not paying anything to acquire the new cryptocurrency. When you trade the asset, you must pay tax on the entire sum. Hard forks and airdrops create an immediate tax responsibility for this year's taxes. In other words, in this year's taxes, you must pay tax on the cost basis (or fair market value at the time of acquisition) of the new crypto. The only condition is that you have technical control over the asset.
Crypto Cost Basis Calculation: Multiple Wallets and Exchanges
Exchanges sometimes generate cost-basis reports where feasible, but they don't know how you acquired cryptocurrencies into your account in the first place. If you have multiple wallets or exchanges, you can't count on exchanges to correctly report your cost basis figures. This will further come into play as 1099 legislation around crypto goes into effect. Specifically around 1099Bs and the yet to be formalized 1099DA form.
A few different scenarios that might break the information found on your crypto exchange forms are:
- Buying or selling crypto in multiple places
- Senting or receiving crypto from other wallets or exchanges
- Storing digital assets on an hard wallet / cold storage
- Participating in an initial coin offering (ICO)
In order to properly account for crypto come tax time, you have to ensure that you merge all of your crypto activity into one report. This is where tools like Ledgible come into play for both individual taxpayers and tax professionals.
Automating Crypto taxes with a crypto calculator
Manual amalgamation, merging, and sorting of data from various exchanges and wallets is time-consuming and laborious. Crypto tax software, on the other hand, can automate the process and help you avoid making costly mistakes.
Ledgible combines your trading history with the exporting mechanism you pick to make accounting easier. The platform automatically computes your capital gains and losses and pre-fills popular IRS forms, such as Form 1040 Schedule D and 8949, after importing transactions from several sources. Ledgible's crypto tax software is a simple tool for determining a cost basis for crypto traders who use numerous exchanges and wallets.