Welcome to CryptoTax!
Understand the three methods for calculating your cost basis.
The IRS provides different methods of calculating cost basis depending on the type of asset. The most common include first in first out (oldest coins sold first), last in first out (newest coins sold first), high cost first out, low cost first out, and the average cost method. The more detailed methods result in more accurate calculations, which may affect the amount you end up paying in taxes. You can work with your accountant to choose which method you want them to use to calculate the cost basis of your assets.
- The first method is the first in, first out (FIFO) method. This assumes that when you sell, you will sell your oldest assets first. So the cost basis is based on your oldest assets.
- The second method is the average basis. In this method, the cost basis is calculated based on the average value of all of your assets.
- The third method is the specific coin identification method. In this method, the cost basis is calculated based on the specific coins you sold.
Using the First In First Out (FIFO) Method
Define Cost Basis:
- Understand the definition of the FIFO method. For this calculation, you would assume that any profit or loss you earned this year came from the sale of securities purchased first. It is the default method for calculating cost basis. Unless you specify otherwise, the IRS assumes that you used this method to calculate the cost basis.
- Calculate the cost basis using the FIFO method.
For example, suppose you own 100 coins of ABC Coin that you purchased 2 years ago for $5,000 (at a cost of $50 per coin) and 100 coins that you purchased 3 years ago for $3,000 (at a cost of $30 per coin) and 100 coins that your purchased 5 years ago for $1,000 (at a cost of $10 per coin). Your total holding at this point was 300 coins of ABC for a total cost of $9,000.This year you sold 50 coins of stock for $3,000.
Using the FIFO method, you would assume that you sold the oldest coins first. This means you sold the 50 coins of the securities purchased initially for a cost of $10.00 per coin or $500 total ($10 x 50 coins).
- Calculate your capital gain or loss.
To calculate your capital gain or loss, you subtract the cost basis from the selling price of the assets. The difference is your gain or loss. This is the amount used to figure your taxes on the sale.
In the above example, the cost basis of the 50 coins sold is $500. The selling price was $3,000. Calculate the capital gain with the equation $3,000 – $500 = $2,500.
Your capital gain in this example is $2,500. This is the amount used to calculate the taxes you owe.
- Consider the benefits.
This method is easy to understand. The assumption is simple, that the coins are sold in the same order in which they were bought. It is also uncomplicated for record-keeping. You don’t have to worry about identifying specific coins you’ve sold and figuring out the cost basis for each.
- Understand the drawbacks.
The FIFO method is less tax-efficient. Your gains or losses are not being calculated in the most accurate way. If you want to minimize your gains or maximize your losses to offset your gains, this is not the best method to use. You have no control over which assets are used to calculate your capital gain or loss.
Using the Average Cost Method
- Understand the average cost method.
This method is typically used for mutual fund accounts. This method adds up the cost basis for all of your assets and divides it by your total number of fund coins to calculate an average cost basis.
- Calculate the cost basis using the average cost method.
Suppose you purchased 100 XYZ fund coins for $5,000 ($50 per coin), 100 fund coins for $3,000 ($30 per coin) and 100 fund coins for $1,000 ($10 per coin). This year you sold 50 XYZ coins for $3,000.
Total the cost for all of the XYZ fund coins ($5,000 + $3,000 + $1,000 = $9,000).
Add up the total number of coins (100 + 100 + 100 = 300).
Calculate the average cost per coin ($9,000 / 300 = $30).
The average cost per coin is $30. You will use $30 per coin for your cost basis.
Since you sold 50 coins, you multiply the cost basis per coin by 50 to calculate the total cost basis (50 x $30 = $1,500).
- Calculate your capital gain or loss.
Subtract your cost basis for the 50 coins from the selling price for the 50 coins. The difference will be your capital gain or loss. This gain or loss is used for your taxes.You sold the 50 coins for $3,000. Subtract to get the difference using the equation $3,000 – $1,500 = $1,500.
Your capital gain in this example is $1,500.
- Consider the benefits.
Your gains and losses are spread evenly across all of the coins you own. It’s also easy to use since the calculation of the average cost is automated. This method involves little record-keeping. Your mutual fund house or stock broker can easily do the calculation for you.
- Understand the drawbacks.
You don’t have as much control over how much of a gain or loss is reported to the IRS for taxes. Because your gains and losses are spread evenly across all the assets you own, you can’t hand select which coins to include in the calculation. Also, this method is tax inefficient. Since the same cost basis is used for all of your assets, you can’t maximize gains or minimize losses for tax purposes.
Using the Specific Coin Identification Method
- Understand the definition of the specific coin identification method. In this method, you identify specifically which coins were sold. You find out the cost basis, or original cost, for each of these coins, and calculate the loss or gain accordingly. This requires the most record-keeping, but it allows for very accurate tax information.
- Calculate the cost basis using the specific coin identification method. Suppose you had purchased 100 XYZ coins on February 12, 2014 for $5000 ($50 per coin), an additional 100 coins of XYZ on March 5, 2012 for $3,000 ($30 per coin), and a third 100 coins on July 7, 2005 for $1000 ($10 per coin).
- Calculate your capital loss or gain. Subtract the cost basis of the coins from the selling price. The difference is your taxable gain or loss. This is the amount you would report to the IRS for tax purposes. The specific coin identification method allows you the freedom to select which of the coins you hold in your portfolio to sell.
To maximize your total gain, you would sell the coins purchased on July 7, 2005 for $10 per coin. The cost basis of the coins would be $500 (50 x $10). The proceeds of the two sales would be $3,000. As a consequence of your selection, you would report a $2,500 capital gain.
Conversely, you could select to sell the coins purchased on February 12, 2014 for $50 per coin. Your cost basis would be $2500 (50 coins x $50 per coin). Since your proceeds are $3,000, your capital gain would be $500 ($3,000 – $2500).
- Consider the benefits. This method gives you more control because you can choose the most advantageous coins to sell. It also makes your tax bill more accurate, and potentially lower than the other two methods by allowing you to specify what to sell to generate the highest possible tax loss. Since you hand-select which coins to sell, you can maximize your gains and manage your income for income taxes.
You can sue your tax losses to offset your capital gains or up to $3,000 in ordinary income.
- Understand the drawbacks. The process of selecting specific coins to sell and calculating the cost basis and capital gains and losses is not automated. It involves a lot of record-keeping. You need to keep track of all of your purchased assets and any adjustments to the cost, including forks, ICO’s and any other transactions. In addition, you need to keep accurate records of the sale of the assets in order to calculate the capital gains or losses.
- How it works
Each time you sell or transfer coins, you select exactly which coins you want us to relieve. It will appear on your statement as SpecID. Our systems support specific identification for all types of coins. If you intend to use this method when you sell coins, we encourage you to set this as your preferred method before you initiate a sale. When you hand-select which coins to sell, you can choose the ones that will minimize your taxable capital gains—or that will reap you the losses you need to offset other gains.
- A few things to consider
Be prepared to be hands-on. Unlike the average cost and first in, first out methods, specific identification isn’t automated—you’ll have to choose specific coins every time you sell assets. We try to make this easier by giving you quick online access to the potential gain or loss for each transaction.
- More recordkeeping may be required
You’ll need to keep detailed records of your adjusted basis. We won’t report cost basis for those coins to the IRS—but we will report it to you, and you’ll need those records to verify that what you eventually report to the IRS is correct. You remain responsible for reporting your cost basis information to the IRS every year on Form 1040, Schedule D, for all coins sold. You should use your own records in addition to the cost basis information we provide.