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promotedCalculate Your Crypto Taxes using the Formulae Below OR Simply Use My Automated Software by@robinyo

August 10th 2019 2,930 reads

Robin is the Founder and CEO of Koinly.io, a cryptocurrency tax solution with portfolio tracking.

A capital gain (profit/loss) occurs when you sell or trade cryptocurrencies and is calculated by subtracting the price you bought the crypto for (cost-basis) from the price you are selling it for. Capital Gain = Selling Price - Cost basis. This seemingly simple formula becomes complicated when you add more transactions as we will see. The amount of tax you pay is a percentage of your total capital gains.

The best and easiest way of explaining the process of calculating your capital gains is through an example. So, in this article we are going to assume that, a fictional character, John has made the following crypto transactions and wants to calculate his capital gains and taxes.

The first step in determining John's capital gains is figuring out the cost basis of the sold cryptocurrency.

We know that John bought a total of 0.75 BTC for 600 USD. So, an easy way of calculating the cost-basis for each of the Sell transactions would be to simply divide 600 by the amount being sold.

This is known as **Average Cost Basis (ACB)**.

There are also other ways of calculating the cost-basis known as **First In First Out (FIFO), Last In First Out (LIFO)** and a special variant known as **Specific Identification (Spec ID)**.

In the US, the IRS allows only FIFO, LIFO and potentially Spec ID to determine the cost-basis. ACB is not allowed in the US but is still widely used in countries like Canada & Sweden.

Let's look at how the cost-basis is calculated using each of these methods.

Average Cost Basis (ACB) is the simplest of all accounting methods. You simply calculate the average price for your holdings in a coin and use that as the cost-basis. The cost-basis for John's two sell transactions can be calculated like this:

Now that we have the cost-basis for all transactions, the capital gains can be easily calculated:

Capital gains for txn #3:

`200 (selling price) - 400 (cost-basis) = -200 USD`

Capital gains for txn #4:

`400 - 210 = +190 USD`

The final capital gains using ACB are -10 USD which means John made a loss of $10.

First In First Out (FIFO) means you have to sell the coin that was bought first, first.

`100 + (500/2) = 350 USD`

` (500/2) + 10 = 260 USD`

Let's calculate the capital gains:

Capital gains for txn #3:

` 200 - 350 = -150 USD`

Capital gains for txn #4:

`400 - 260 = +140 USD`

Here the final taxable gains are

`140 - 150 = -10 USD`

. Again, a loss of 10 USD.Last In First Out (LIFO) is the opposite of FIFO - here the most recently bought coins are sold first.

`100 + 10 = 110 USD.`

The capital gains are calculated in the same way as FIFO/ACB:

Capital gains for txn #3:

`200 - 500 = -300 USD`

Capital gains for txn #4:

`400 - 110 = +290 USD`

The final capital gains are thus

`-10 USD`

.Specific Identification allows you to pick the assets that you want to sell instead of simply relying on the date of purchase like with FIFO/LIFO. SpecID is generally used when selling stocks/bonds and is allowed by the IRS (United States) on the proviso that you can 'adequately identify' the lots that you are selling. It is not known if cryptocurrency holders can make use of it - as cryptocurrency is classified as property.

Alice bought 1 BTC for 1000 USD in January and another 1 BTC in Feb for 5000 USD. She sold 1 BTC in May for 4000 USD. Here are her transactions:

Alice has decided to use SpecID. She is aware that she must be able to identify the BTC that she is selling in order to make use of SpecID. To comply with this requirement, the 1 BTC she bought in January is stored in address 0x11111 and the BTC she bought in Feb is stored in 0x22222. This setup allows her to 'adequately identify' the lots that she is selling.

If she sells 1 BTC from 0x11111, her cost-basis would be +3000 USD (profit). If she sells 1 BTC from 0x22222, her cost-basis would be -1000 USD (loss). With this knowledge Alice is much better equipped to make tax-efficient trades.

However, as already mentioned, there is no guideline on whether SpecID is allowed for cryptocurrencies yet.

As you can see all methods resulted in a loss of -10 USD. However, this is due to the low number of transactions and the fact that all of the bitcoin was sold. Under real trading conditions the results of FIFO, LIFO and ACB can be quite different.

Ultimately the choice of method comes down to what is allowed in your country. If you are US based - you have several options but the most recommended and conservative one is FIFO. In countries where you are allowed to choose between different methods it is important to be consistent. You will need to pick a method and stick to it. It is generally quite difficult to switch a method and doing so usually requires authorization from the tax agencies.

With cryptocurrency tax reporting, the most crucial thing is to keep track of *ALL *your transactions and trades. If you are a daredevil you may attempt to do your crypto taxes with excel but be prepared to spend many hours on it - generating accurate crypto tax reports is a very time-consuming and elaborate process. Luckily, there are now crypto tax calculators that can easily do this for you.