“Tax gain, I’ve had enough”. Already, if you want to make America Great Again by paying more for Uncle Sam. Just go ahead and don’t read this post. Here’s the post that will tell you everything you need to know about cost basis and how to use it.
Cool, what’s cost basis?
Well, cost basis is simply the purchase price of an asset for tax purpose. For instance, Bob buys 1 bitcoin for $ 3000. The cost basis of the bitcoin is $ 3000.
If cost basis is so simple, why should I care? The problem is Bitcoin users may buy and sell many times. It’s more difficult to track the cost basis of sold Bitcoin. There are 3 allowed methods to calculate the cost basis:
- FIFO It’s not “Fucking Idiot From Ohio” (if you Google). FIFO stands for “First in, First out”. This method assumes that what you buy first, you sell first. For example, Bob bought 2 bitcoins for $ 300 in 2012 and 1 bitcoin for $ 1000 in 2014. In 2017 when the price of bitcoin reached $ 3000, he sold 1 bitcoin. The cost basis of the bitcoin is $ 300.
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LIFO stands for “Last in, First out” This method assumes that what you buy last, you sell first. Applying to the above example, the cost basis of the bitcoin is $ 1000.
- Specific identification As its name suggests, you keep track of your Bitcoin and know exactly which bitcoin you sell. It’s impossible in real life.
Why it matters?
To illustrate how each method affect your taxes. We suppose that Bob (in the 25% income-tax bracket) make the following purchases:
| Date | BTC | Purchase cost | Market price now |
| Nov. 2012 | 20 | $20 | $2700 |
| Oct. 2013 | 15 | $ 1000 | $2700 |
| Nov. 2013 | 40 | $ 900 | $2700 |
Now he wants to sell 30 BTC. For specific identification method, he sells 15 BTC from Oct. 2013 and 15 BTC from Nov. 2013. Here's the amount of tax for each method:
| Date | FIFO | LIFO | Specific identification |
| Cost basis | 20*20 + 10*1000= 10 400 | 30*900 = 27 000 | 15*1000 + 15* 900 = 28 500 |
| Proceeds | 81 000 | 81 000 | 81 000 |
| Gains | 70 600 | 54 000 | 52 500 |
| Tax results | 17 650 | 13 500 | 13 125 |
It’s clear that Specific identification > LIFO> FIFO, in terms of tax- friendliness. Over the long term prices rise rather than fall. As long as prices are rising, using FIFO will produce a larger profit, a larger net income and, in turn, a larger tax bill.
One thing to note is that the report by Coinbase uses the FIFO method (the least tax-friendly). Those methods are applicable to Bitcoin, Ethereum, Gridcoin or any other cryptocurrencies.
Stay tuned.
