Crypto assets have been the subject of a lot of stress and confusion when it comes to taxes. Despite its ambiguous guidance, the tax agency sent thousands of letters to crypto traders and investors warning them to pay the tax that they owe or face fines and other penalties.
Let's take a look at some of the challenges associated with tracking cost basis—especially across different wallets and exchanges—as well as how to resolve them.
What is Cost Basis?
The cost basis is the amount that you spent to acquire an asset, including the purchase price, transaction fees, brokerage commissions and any other relevant cost.
The equation is relatively simple: (Purchase Price + Fees) / Quantity
For example, suppose that you invested $150 into Bitcoin on April 1, 2020 for $6,537 with a 1.49% transaction fee. Your cost basis would be your total purchase price of $152.24 ($150 + 1.49%*150) divided by 0.023 ($150/$6,537) — or $6,619 per BTC.
The cost basis also depends on your accounting method:
- First in First Out (FIFO) - The cost basis for a sale is the cost basis of the earliest crypto that you acquired.
- Last in First Out (LIFO) - The cost basis for a sale is the cost basis of the last crypto that you acquired.
- Actual Cost Basis - Each cryptocurrency is tracked and any sale is the sale of a specific coin.
For example, suppose that you're using FIFO and you acquired one Bitcoin in 2017 and two Bitcoins in 2018. If you sell two Bitcoins in 2019, you would use the cost basis for the 2017 purchase and one of the 2018 purchases.
The cost basis is important because it's used to calculate your taxable gains. The capital gain or loss of a position is the difference between your cost basis and sale price—or the fair market value at the time of the sale.
The cost basis is relatively straightforward for cash-to-crypto transactions, but crypto-to-crypto transactions are a different story, and involve an extra step in the process.
Suppose that you sold one Bitcoin to acquire the equivalent value in Litecoin. The cost basis for the Litecoin would be the fair market value of the Bitcoin at the time of sale in U.S. dollars plus any fees. For example, $6,500 plus a 1.49% transaction fee of $96.85 divided by 144—or, $45.88 per LTC.
You should keep a record of each transaction to ensure that you have the right cost basis on file. Otherwise, you may have to short through historical data to find the fair market value for different cryptocurrencies at different times. The good news is that you can use reputable price indexes in the process.
Initial Coin Offerings (ICOs)
The cost basis can also be complicated by the lack of liquidity. For example, how do you know the cost basis of a thinly traded initial coin offering (ICO)?
ICOs were initially designed to finance early-stage blockchain projects using a crowdfunding approach. Investors received tokens (e.g. vouchers) that they could use to pay for future services being developed by the issuing firm. These 'utility tokens' have been replaced by 'tokenized securities'.
While the cost basis for ICO investors is fairly straightforward, the cost basis for issuers is a little less certain. The IRS says that the issuance of 'utility tokens' for cash, crypto or other property will be treated as the sale of property in which the issuer has a zero cost basis.
Crypto from Forks & Airdrops
The cost basis of a hard fork or airdrop is zero since you're not paying anything to acquire the new cryptocurrency. When you sell the asset, you must pay tax on the entire amount.Hard forks and airdrops also create an immediate tax obligation for the current tax year. In other words, you owe tax on the cost basis (or fair market value at the time of acquisition) of the new crypto in the current tax year. The only requirement is that you have technical control over the asset.
The good news is that there has been a lot of pushback among lawmakers for better solutions. After all, many crypto holders don't have an option when it comes to being on the receiving end of a hard fork or airdrop and they may not realize any cash gains if they don't sell it.
Multiple Wallets & Exchanges
Many exchanges prepare cost basis reports where possible, but they don't know how you originally acquired cryptocurrencies that you've imported into your account. If you use multiple wallets or exchanges, you cannot rely on exchanges to accurately report your cost basis figures.
Exchange cost basis calculations don't work if you've:
- Bought or sold digital assets from elsewhere.
- Sent or received digital assets from elsewhere.
- Stored digital assets on an external device.
- Participated in an initial coin offering.
- Used different accounting methods than the exchange.
You must merge transactions from all of your exchanges and wallets into a single data set to determine cost basis:
- Aggregate transactions from every exchange by exporting to CSV or other file formats that can be easily compared.
- Merge the transactions and sort them by date to understand when each transaction occurred.
- Determine the cost basis for each transaction based on your accounting method (FIFO, LIFO, Actuals, etc.).
Automating the Process
The process of manually aggregating, merging and sorting data from multiple exchanges and wallets is tedious and time-consuming. Fortunately, crypto tax software can automate the process and help you avoid making costly mistakes.
ZenLedger provides an easy-to-use solution for crypto traders and investors with multiple exchanges and wallets. After importing transactions from multiple sources, the platform automatically computes your capital gains and losses and pre-fills popular IRS forms, like Form 1040 Schedule D and 8949.
The Bottom Line
Cost basis is one of the most important concepts in crypto accounting and tax. While it can be fairly straightforward, there are some important considerations to keep in mind, particularly with airdrops, forks, ICOs and other edge cases.
If you're using multiple exchanges, you must also aggregate transactions to ensure that you're properly calculating your cost basis. Crypto tax software, like ZenLedger, can simplify the process and ensure that you are accurately reporting data.