Calculating your crypto taxes? You need to be able to accurately figure out your cost basis to know your capital gains and losses. Using certain cost basis methods can even optimize your crypto tax position - learn how.
Put simply, your cost basis is the original price you paid for an asset - in this instance, crypto.
Knowing your cost basis is vital to help you accurately calculate your cryptocurrency profits and losses. You subtract your cost basis from the price you sold your asset for to calculate your capital gains or losses.
This sounds simple, but there are many cost basis methods available to pick from when calculating your crypto taxes. To further complicate things, many countries have stringent rules regarding which cost basis method to use, and when.
It isn’t all bad news - using the right cost basis method when you have several to choose from can actually help you save on your crypto taxes.
What is cost basis in crypto?
In accounting, we need to know the cost basis of an asset, like a share or a cryptocurrency, in order to calculate our profit on the day we sell, swap or spend that asset.
In the case of crypto tax, the cost basis is the original price plus any related fees, of the crypto on the day you took ownership of it - whether you bought it, were gifted it or had it airdropped to you. When calculating the cost of an asset you purchased, you can also add any transaction fees you paid when you bought/sold it.
For example, let’s say you bought 0.5 BTC for $30,000 and you paid a 0.5% buy fee, so $150. Your cost basis would be $30,150.
You later sell your 0.5 BTC for $32,000. You pay another 0.5% sell fee, so $160. Your cost basis is now $30,310. You can calculate whether you made a capital gain or loss by subtracting your cost basis from your sale price. In this instance, $32,000 - $30,310 = $1,690. You made a capital gain of $1,690 and you’ll need to pay Capital Gains Tax on this amount.
When do you need to calculate your cost basis?
Though we’ve used the example of selling BTC above, you actually need to calculate your cost basis and subsequent capital gains or losses anytime you ‘dispose’ of a crypto asset from a tax perspective.
Disposing of an asset refers to selling, swapping or spending your crypto, as well as gifting it in some countries.
Why are there different cost basis methods?
Now we’ve covered the basics, you’re probably wondering why there are different cost basis methods when it’s all pretty straightforward in our example above. We’ll use a different example to explain.
You bought 1 BTC for $7,000 in December 2019. In January 2021, you bought 1 BTC for $35,000. This month, you sold 1 BTC for $31,000.
If you calculate your cost basis using your first investment, you made a capital gain of $28,000, which would be subject to Capital Gains Tax. But if you calculate your cost basis using your more recent BTC investment, you had a capital loss of $4,000.
There's a huge disparity between the two calculations and it has big implications for your tax bill. So, how do you know which cost basis method to use?
There are several different cost basis methods to pick from, including:
- First In, First Out (FIFO)
- Last In, First Out (LIFO)
- Average Cost Basis (ACB)
- Highest Cost, First Out (HIFO)
- Lowest Cost, First Out (LCFO)
- Specific Lot Identification (Spec ID)
- Loss Gain Utilization (LGUT)
As well as these cost basis methods, there are also some country specific cost basis rules like the same-day rule and 30-day rule for UK crypto investors.
Your tax office will give specific guidance on the cost basis methods available to you. Some countries, like the USA, allow you to pick from several cost basis methods, while others, like the UK, have stringent rules about which cost basis method to use and when.
We’ll look at each cost method separately, followed by specific country guidance on which to use.
FIFO crypto tax
First In, First Out (FIFO) is one of the most common cost basis methods and it's very straightforward. FIFO means the first asset you buy is the first asset you sell.
From a tax perspective, FIFO can be beneficial as it allows investors to take advantage of long-term Capital Gains Tax discounts which are often much lower than short-term Capital Gains Tax rates.
However, as long-held assets have often appreciated in value the most FIFO can often leave investors with the highest gains and therefore the largest Capital Gains Tax bill.
LIFO crypto tax
The Last In, First Out (LIFO) cost basis method is the opposite of FIFO. Instead of using the cost basis method of the asset you purchased first, you use the cost basis of the asset you purchased most recently.
The pros and cons of the LIFO cost basis method are essentially the opposite of FIFO. You may be subject to higher short-term Capital Gains Tax rates. However, investors may pay less tax overall as their most recently purchased assets may not have appreciated in value as much. As the crypto market is so volatile, in some instances using the LIFO method will result in more capital losses, which are not subject to tax.
ACB crypto tax
Average cost basis (ACB) is another simple cost basis method and often the preference when dealing with other financial assets like shares.
To calculate the cost basis using ACB, you need to figure out an average cost for all assets. You calculate this by adding up the total amount you paid to buy your asset(s) and divide it by the total amount of coins/tokens held.
For example, if you held 5 BTC all bought for different amounts, you’d add up these different amounts then divide this by 5. You’ll need to do this for all the different cryptocurrencies in your portfolio.
Average cost basis shouldn’t be confused with adjusted cost basis - which is a cost basis method used specifically in Canada (more on this later).
HIFO crypto tax
The Highest In First Out (HIFO) cost basis method means it doesn’t matter when you purchased an asset, it's all about how much it cost you to buy the asset. The highest price you paid for a given asset is the cost basis you use when you sell it.
The benefits of HIFO for investors are clear - the larger the cost basis, the lower the capital gain. The HIFO cost basis method will generally result in the lowest Capital Gains Tax bill.
However, not all countries allow investors to use the HIFO cost basis method when calculating their capital gains.
LCFO crypto tax
Like FIFO and LIFO, the Lowest Cost First Out (LCFO) cost basis method is the opposite of the HIFO cost basis method. You'll use the lowest cost basis available for a given asset when calculating your capital gains and losses.
The pros and cons of LCFO are similar to LIFO. You may benefit from discounted long-term Capital Gains Tax rates, but you'll also likely end up with a higher net capital gain than with other methods.
Spec ID crypto tax
The Specific Identification (Spec ID) cost basis method lets you use the actual cost basis for the asset you sold. This is much easier to track with digital assets thanks to TXN numbers than it is with other financial assets like shares.
The big con of this is that if you're not using cryptocurrency tax software and you trade at volume, then calculating your cost basis for every disposal manually can be a time consuming affair. It is, however, the most accurate way to report your real capital gains and losses compared to other methods and will hold up best under scrutiny by tax authorities.
LGUT crypto tax
The Loss Gain Utilization (LGUT) cost basis method means you use the cost basis that would result in the largest loss first. You can't use the same cost basis over and over again,so you’ll work through your available cost basis options from the largest loss to the smallest. Short-term losses are prioritized over long-term losses.
By using the LGUT cost basis method, you'll end up with the lowest Capital Gains Tax bill possible that year, so the benefits are obvious. However, many tax offices don't allow the LGUT cost basis method and even many of the tax offices that do allow it haven't yet clarified whether LGUT cost basis may be used when calculating crypto capital gains taxes. So if you want to use the LGUT method, you should speak with an accountant for advice beforehand.
Which cost basis method should you use for crypto taxes?
As you can see, with so many different cost basis methods available, there are a lot of ways to calculate your capital gains and losses - all of which will affect your Capital Gains Tax bill. In countries where you can choose the cost basis method you use, the best cost basis method to use is the one that allows you to optimize your tax position.
Let’s say you made the following purchases over a period of time in this chronological order:
- April 2019 Buy: 1 BTC for $7,000.
- December 2020 Buy: 2 BTC for $15,000.
- June 2021 Buy: 1 BTC for $35,000.
This tax year, you sold 1 BTC for $30,000. You made a disposal and you need to calculate your gain or loss. You know the asset you sold was bought in December 2020 from the TXN number.
Use the Bitcoin tax spreadsheet below to see how each cost basis method changes how you calculate Bitcoin tax and your resulting gains and losses.
In a best case scenario from a tax perspective, you’d be registering a loss of $5,000 with your tax authority, which you can offset against any other gains. In a worse case scenario, you’d be paying Capital Gains Tax on a gain of $23,000.
Some countries - like America - let you pick the cost basis method you use. This lets you pick the cost basis method that optimizes your tax position. It’s important to understand that once you’ve used a specific cost basis method to calculate and report your capital gains and losses, you can’t change it retrospectively.
In some countries, you’ll need to stick with one cost basis method for good. In others, you’ll be able to change the cost basis method you use each financial year to suit you - provided it doesn’t affect your previous calculations.
In general, the best rule of thumb to avoid an unwelcome audit is to pick one cost basis method and stick with it every financial year for consistency.
All this said, some countries give specific guidance on which cost basis methods you can use. We’ll look at how some tax offices around the world calculate crypto taxes.
IRS Cost Basis Method
The IRS doesn’t give investors a specific cost basis method to use, however, once you pick a cost basis method, you must use that method consistently when calculating your gains and losses.
FIFO and ACB are the most common methods used by American investors. However, the IRS also clarified that crypto investors are able to use the Spec ID cost basis method.
There are other cost basis methods available to investors that wish to take a more aggressive tax strategy. If in doubt, contact the IRS and clarify which cost basis methods you can use before calculating and reporting your crypto taxes.
You can find more information in our US Crypto Tax Guide.
HMRC Cost Basis Method
The UK’s HMRC has very specific rules for crypto cost basis methods, known as share pooling. This is to stop crypto investors from manipulating the ACB method by purchasing and selling assets at a loss in a short period of time to create an unrealistic view of gains and losses.
In the UK, there are three possible cost basis methods you can use and you need to work through them in order of which applies to your assets:
- Same-Day Rule: If you buy and sell coins on the same day, you need to use the cost basis on this day to calculate your gains/losses. If you’re selling more than you bought on that day, move onto the next rule.
- Bed and Breakfasting Rule: If you buy coins/tokens and sell the same coins/tokens within 30 days, you’ll use the cost basis of coins/tokens you bought within this month to calculate your gains/losses. If you’re selling more than you bought within this month, move onto the final rule.
- Section 104 Rule: If the above two rules don’t apply to any of your crypto transactions, you need to use this cost basis method when calculating your crypto taxes. This works like the ACB method in that you calculate an average cost basis for a pool of assets by adding up the total amount paid for all assets and dividing it by the total amount of coins/tokens held.
You can find more information in our UK Crypto Tax Guide.
ATO Cost Basis Method
For Australian investors, the ATO lets you use a variety of cost basis methods when calculating your crypto capital gains, though FIFO and ACB tend to be the most common.
For Australian traders, your cost basis method is limited to FIFO or ACB.
You can find more information in our Australian Crypto Tax Guide.
CRA Cost Basis Method
The Canadian Revenue Agency says taxpayers must use the adjusted cost basis method when calculating crypto capital gains and losses. The adjusted cost basis method is the cost of an asset plus any fees related to it.
You can either use the fair market value (FMV) of the asset at the point you acquired it or the FMV of the asset at the end of the year - whichever is lower. For this reason, you need to keep very accurate records of your crypto transactions in Canada.
For investors with multiple assets, you can choose to value your entire inventory for its FMV at the end of the year instead.
You can find more information in our Canada Crypto Tax Guide.
How to calculate cost basis for crypto with Koinly
Koinly calculates your cost basis and resulting gains or losses for you, based on the preferred cost basis method in your country. For example, share pooling is the default cost basis method for UK Koinly users. For investors with a variety of cost basis methods to pick from, you can head into your settings in Koinly and pick the cost basis method you want to use and let Koinly do the rest.
Koinly supports the following cost basis methods:
- Share Pooling (for UK users only)
- Adjusted Cost Basis (for Canadian users only)
- Your cost basis is the original price you paid for a coin/token, plus any transaction fees.
- You subtract your cost basis from the price you sold an asset for to calculate your capital gains or losses.
- You need to calculate your capital gains anytime you sell, swap or spend crypto (as well as gift in some countries).
- Different countries use different cost basis methods.
- The cost basis method you use can help you optimize your tax position.
- The most common cost basis methods are First In, First Out and Average Cost Basis.