April 6, 2022

How to Find the Best Crypto Cost Basis

Written by Mark Kang, CPA Updated April 6, 2022

How would you classify cryptocurrency?

From the IRS’s perspective, a cryptocurrency is property for tax purposes. This means that if you sold your crypto and made some profit, it will be considered capital gain and you may owe capital gain tax.

But did you know that there are a number of “cost basis methods” that can play a key factor in reducing your capital gains taxes?

Let’s walk you step-by-step through the process of figuring out the best cost basis.

 

Step 1. Know what “cost basis” means

To understand what the cost basis is, take a look at this formula.

Total Sale Price - Cost Basis - Selling Expenses/Fees  

=  Crypto Capital Gains/Losses

 

“Cost basis” simply means how much the crypto’s value was when you first got them. Your income and crypto tax rate can change considerably depending on how you calculate your cost basis. How about some examples?

Mimi bought 0.5 BTC for $25,000 and then sold it for$29,000 a few days later without any transaction fees. 

Crypto cost basis, example 1

Mimi just had a $4,000 crypto capital gain and she should report this capital gain on her tax return. 

Crypto cost basis, example 2

FYI, there are two different capital gains tax rates depending on how long you’ve held your crypto before selling it. To learn more about this, click here

 

Step 2. Understand the various cost basis methods

Then how can we determine which cost basis belongs to which sale amongst multiple crypto purchase transactions?  

Actually, there are different ways to choose and calculate your cost basis as follows.

FIFO (First In, First Out)
FIFO is a cost basis method where you take the earliest unit you’ve bought and use that as your cost basis. This is the default method to calculate your capital gains, and also the easiest and most convenient since this maximizes the time you’ve held your assets. This means your long-term capital gains increase, and those are usually taxed at lower rates.

LIFO (Last In, First Out)
LIFO is the opposite of FIFO; you use the most recent unit you’ve bought as your cost basis. This is useful for maxing out short-term capital gains, but it’ll cut into your long-term capital gains as assets tend to grow gradually over time. LIFO is useful for frequent transactions such as day trading.

HIFO (Highest In, First Out)
Unlike FIFO and LIFO, HIFO uses the most expensive purchase price you have as your cost basis. This is something you have to be careful with, since it can result in larger capital gains in the future but also you should be very cautious about duplicate transactions. HIFO can still be the most useful cost basis method if you’re looking to calculate capital gains for a one-year period.

Specific ID
Specific ID is a much more flexible way (and arguably the riskiest) of calculating capital gains, since it lets you choose a specific unit as your cost basis - it doesn’t have to be the earliest, the latest, or the most expensive unit at all. Specific ID lets you reduce your crypto capital gains tax by matching each selling price to specific units and letting you prioritize long-term or short-term gains.

 

Step 3. Implement the cost basis methods to multiple crypto transactions

In this step, we’ll figure out how different cost basis methods can bring different outcomes and find the best crypto tax-saving scenario with an example.

Marko bought -

1 BTC at $10,000 in May 2017

1 BTC at $20,000 in May 2018

1 BTC at $19,000 in December 2018

1 BTC at $17,000 in May 2019

1 BTC at $20,000 in May 2020

 

He then sold 2 BTC at $30,000 each ($60,000 in total), in January 2021. 

Let’s assume there were no transaction fees.

 

crypto-cost-basis

 

Let’s walk through how each cost basis method would work and see how they differ. Keep in mind that since you sold two units in January 2021, we will also take two units into account when calculating the overall gains (or losses).

 

FIFO
We need to pick the two earliest units: 

An example of crypto FIFO cost basis

 

  • $10,000 in May 2017
  • $20,000 in May 2018
  • FIFO cost basis will be $30,000
     

Total Sale Price - Cost Basis = $60,000 - $30,000 = $30,000 capital gain

 

LIFO
We need to pick the two latest units:

An example of crypto LIFO cost basis

 

  • $20,000 in May 2020
  • $17,000 in May 2019
  • LIFO cost basis will be $37,000
     

Total Sale Price - Cost Basis = $60,000 - $37,000 = $23,000 capital gain

 

HIFO
We need to pick the two highest units:

An example of crypto HIFO cost basis

 

  • $20,000 in May 2018
  • $20,000 in May 2020
  • HIFO cost basis will be $40,000
     

Total Sale Price - Cost Basis = $60,000 - $40,000 = $20,000 capital gain


Specific ID
We will pick two random units for better understanding:

An example of crypto specific ID cost basis

 

  • $20,000 in May 2018
  • $19,000 in December 2018
  • Specific ID cost basis will be $39,000
     

Total Sale Price - Cost Basis = $60,000 - $39,000 = $21,000 capital gain


So as you can see, each cost basis method gives you different results. In this case, our capital gains are listed as the lowest with HIFO

Keep in mind that in the case with HIFO, both long-term (0%-20%) and short-term (15%-37%) capital gain tax rates will be applied for each BTC sale out of 2 BTC sales. 

The IRS hasn’t provided any detailed guidelines yet on the Tax Lot ID method, but based on their FAQs, sections A39, A40, and A41:
 

  • If you can’t ID the unit(s) of crypto that you sold, use the first in, first out (FIFO) method. Basically, use the crypto you bought the earliest if possible. 
  • If you can ID the unit(s) you sold, you can use any cost basis method but need to make sure that you keep accurate records of all of your transactions.

One last thing: choosing the right cost basis is very important because it is recommended that you be consistent with your choice of cost basis method every year.

 

Wrapping Up

It’s definitely challenging to figure out your choice of the cost basis method for your entire sales. Moreover, you need to come up with the most effective tax-saving strategy before the tax return due date (April 15, 2022). It’s time to use crypto tax software to save time and crypto taxes. Click here to go to our homepage and find out more.

 

Got any crypto tax questions? Ask us on Twitter! Our co-founder & crypto tax expert Daniel @Cointelli_Dan will answer you directly!

 

 

DISCLAIMER: This post is for informational purposes only and should not be interpreted or relied upon as a substitute for the advice of financial, legal, or tax professionals. This content also only addresses U.S. federal income tax consequences for U.S. citizens and residents and does not address tax consequences that may be relevant to a particular person subject to special rules, such as dealers or traders. You should consult with your own financial, legal, or tax professionals to report and file your crypto taxes or make decisions on your particular circumstances. The laws, regulations, or interpretation of the existing laws could change, which may adversely affect either prospectively or retroactively. The content of this post is subject to changes.
About the Author
Mark Kang, CPA
CEO & Co-founder of Cointelli
Mark Kang is a CPA with a Ph.D. in Physics. He helped build Cointelli’s foolproof formula for accurate crypto tax reporting. Passionate about crypto tax topics, Mark is here to share the knowledge.

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About the Author
Mark Kang, CPA
CEO & Co-founder of Cointelli
Mark Kang is a CPA with a Ph.D. in Physics. He helped build Cointelli’s foolproof formula for accurate crypto tax reporting. Passionate about crypto tax topics, Mark is here to share the knowledge.
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