Adam Efrima is the cofounder of Blox.io.
The pursuit of calculating cost basis for cryptocurrency is one that has been hindered by obstacles from three separate external factors; a gap in guidance for crypto regulation; a lack of legally approved best practices for crypto accounting and taxation; and smart technology to automate and increase accuracy and remove human error out of cost basis results.
To help the crypto community, tax professionals and to keep the world informed on how to calculate cryptocurrency cost basis, here are the most important questions and answers that crypto owners must know.
What is the difference between traditional and crypto cost basis?
Cost basis is a traditional accounting term that refers to the purchase price + fees + other associated purchase costs. The core of “basis” is the same for cryptocurrency cost as it is for traditional cost basis for calculating gains & losses. Essentially, anyone and everyone that makes a profit is expected to pay annual taxes on capital gains.
Traditionally, when calculating gains and losses, professionals will rely on general ledger software such as Quickbooks, accompanied by spreadsheets, calculators and lots of manual data entry and calculations. Additionally, traditional cost basis has clear regulations for tax obligations and compliance, while also having a more understandable financial ecosystem.
This makes calculations more simple and predictable to calculate.
To describe crypto cost basis more easily, if Jack purchased a Bitcoin in 2015 for $400, the basis on that Bitcoin is $400. If Jack sold his Bitcoin one-year later for $2000, he would owe taxes based on his gains of $1600. (Fees & other difficult factors are removed for this example)
Jack’s Original Purchase 2015: $400
Jack’s Basis with Fees 2016: $400
Jack’s Sale Price of Bitcoin: $2000
Jack’s Taxable Gains: $1600
For calculating cryptocurrency cost basis, the process becomes far more complex. There are thousands of different types of cryptocurrencies that operate in different ways. Crypto also contains far more variables such as gas fees for fueling transactions within a crypto network, exchange or transfer fees, mining profits, soft and hard forks, airdrops and dozens of intricate taxable nuances.
It's simple to see that crypto can be far more perplexing.
Why is cost basis important to me?
Cost basis is used to calculate a company or investors total gains or losses on an annual basis, usually for auditing or tax purposes. In the U.S, the government requests and requires all holders of cryptocurrencies to disclose their entire financial portfolio and have it reported annually for capital gain taxes.
For the IRS to properly audit and assess an investor or businesses financials, they will require a complete overview of asset and transaction history to understand how much or how little a company or individual earned in crypto annually,
By effectively and accurately reporting cryptocurrency holdings, gains or losses, in adherence to the tax obligations issued by the IRS, cryptocurrency investors that report their earnings not only remain legally safe, but can also see exemptions and other possible benefits of reporting promptly and properly.
What happens if I don’t calculate or report my crypto cost basis?
While the regulation and legal framework are still being built, the consequences of neglecting to disclose a complete history of a digital asset portfolio can be punished by the federal tax arm of the government, the Internal Revenue Service. It is essential for cryptocurrency owners, investors, businesses and any operations that transacts with crypto to report and pay their annual taxation requirements.
New tax forms now officially include sections to disclose your cryptocurrency earnings for the year. While the issue of disclosing personal crypto portfolio information has been disputed by many in the crypto community, this is an official law approved by the American federal government, making it unequivocally legal and enforceable.
There is destined to be edge cases where no legal framework exists, such as if an exchange is defunct and investors lost access to their transaction history. Every case is different, but reporting honestly and proactively, as well as staying informed is the best way to stay on the right side of the law.
How do I calculate my crypto cost basis?
Calculating cost basis for crypto is exceptionally difficult due to the secure nature and wild web of complex transactions and taxable financial events. The best place to start is by noting down all wallets, exchanges, accounts and portfolios to ensure investors have the full picture of their crypto portfolio.
Investors and businesses alike may rely on third party accounting services to help calculate crypto cost basis, while small investors will look for software and more feasible solutions.
It is not recommended to manually calculate cost basis due to the extreme complexities of transaction activity and the behavior of the ecosystem.
Moreover, calculating gains and losses on 100 transactions manually can take hundreds of hours, pouring over spreadsheets, documents and hoping for an accurate result. Unless your are a well-trained finance professionals, leveraging technology, or accounting firms is usually the safest best for investors and businesses.
Are there tools to help me calculate my crypto gains and losses?
For investors and businesses of any size, there are technological solutions capable of calculating cryptocurrency gains and losses easily. Blox, a leading platform for crypto accounting, tax and asset management has developed the industry’s first automated and accurate cryptocurrency cost basis tool.
Other software of startups such as TokenTax exist with the goal of helping crypto businesses and investors with the day-to-day and back office software solutions for managing their crypto or calculating gains and losses. Tech and software can work together to help keep investors and professionals more organized and connected to their crypto with full control and management of assets.
It is always important to investigate the right platform for each business and individuals, and leveraging technology on a day-to-day basis. This will ultimately help to keep track, organize and prepare for tax season, auditing, financial accounting and other tax obligations.
What is next for cost basis?
The dominance of bitcoin, despite its epic price fluctuations, has made it more important than ever, to begin calculating gains and losses for investors, businesses and institutions. In the eyes of the IRS, anyone and everyone is entitled and liable to pay taxes on crypto earnings.
The evolving landscape of crypto taxation is slowly changing everyday, and creating new rules and regulations for how to calculate gains and losses and navigate the financial world of cryptocurrencies.
For businesses, they may already have an internal finance team, or hire external accounting firms to handle bookkeeping and taxation. But for small individual investors, they must rely on more localized and cost effective means for calculating cost basis. Regardless, businesses and investors of all shapes, sizes and networth are all governed by the same tax laws.
(Disclaimer: The Author is a co-Founder at Blox.io)