What is cost basis? Cryptocurrency gains explained
(a.k.a. how to calculate your taxable income on crypto)
Ok, first of all, what is cost basis and why should you care?
Put simply, cost basis or just “basis” is equal to the amount of money in US Dollars that an asset cost you to acquire. For example, if you were one of the early-adopters, reading this post from the back-seat of your new Maybach, and you bought 1 Bitcoin for $200 back in 2013 your basis in that Bitcoin would be $200.
Ok, I understand what basis is, so remind me why I should care?
You should care because cost basis is used to calculate your gain or loss on a sale or exchange of what the IRS calls a “Capital Asset”. What a Capital Asset is doesn’t matter all that much right now, all you need to know is that the IRS has ruled that Cryptocurrency is one…for now. Other Capital Assets include, Stocks and Securities, Copyrights, Interest in a Partnership, and Real Property (Land, Buildings, etc.).
If you want to learn more about this designation, please see the following IRS tax notice from 2014: here.
^TL;DR:
Cryptocurrency is a capital asset, and the amount a cryptocurrency cost you to acquire either through purchase or exchange is called “cost basis” or “basis”.
Ok, so what does all this mean in terms of me paying my 2017 taxes?
In order to calculate gain or loss on a sale or exchange of your cryptocurrency you must first know your cost basis in that cryptocurrency. Using our example from earlier, you know the one about the guy sipping champagne in his Maybach telling Alfred to turn up the music, we said that the basis was $200 for Bitcoin bought in 2013.
Let’s take a look at what happens if Richie Rich tries to sell or exchange that Bitcoin today. For simplicity, we will ignore transaction fees, but keep in mind any fees you pay on exchanges like Coinbase to purchase or exchange cryptocurrency would be included in the basis of that asset. For example, if you have to pay a bank fee of $3.25 on top of the purchase price of the crypto that $3.25 would be added to the basis.
Sale:
On 2/20/18 a Taxpayer sells Bitcoin purchased for $200 in 2013 for US Dollars.
Cost Basis: $200 (includes transaction fees)
Sale Price: $11,875
Taxable Gain on Sale: $11,675
Basis in Bitcoin after Sale: $0
Exchange:
On 2/20/18 a Taxpayer exchanges Bitcoin purchased for $200 in 2013 today in full for Ripple.
Cost Basis: $200 (includes transaction fees)
Price of Bitcoin at exchange: $11,875
Basis in Bitcoin after Exchange: $0
Basis in Ripple after Exchange: $11,675
Taxable Gain on Sale: $11,675
Do you see how regardless of whether or not the Bitcoin was sold or exchanged the Taxable gain is the same? This is because in both scenarios the basis in Bitcoin has increased by $11,675 since the time of acquisition.
Until the Bitcoin is sold or exchanged that increase is referred to as a “Realized” gain, Realized gains are not taxable. However, the moment that the Bitcoin is sold or exchanged that triggers what is call gain “Recognition”. Once a gain has been recognized the amount of gain is taxable.
The same rules apply for losses, losses can be realized but not recognized, when a loss is recognized that can trigger a taxable event that creates a loss carryforward.
Getting too technical? I apologize, but this stuff really gets me going!
For more explanation of the tax rules and the tax rate you may pay on the gains explained above please see Zac’s post here.
^TL;DR:
The taxable gain on the sale or exchange of cryptocurrency is equal to the price of the asset at the time of sale or exchange (so today Bitcoin at $11,875) less the basis (original price of the asset at time of acquisition, or $200 from our example). This means the taxable gain on the sale of exchange would be equal to the increase in basis over the holding period, or $11,875 — $200 = $11,675.
Ok, so how am I supposed to keep track of all of this?
Well, good news for you, that’s why we’ve come up with TokenTax! Instead of worrying about calculating your basis for each transaction you make during the year (and we know that can be a lot!) TokenTax automatically links with your Coinbase, GDAX, or Bittrex accounts to calculate your basis, gains, losses, and total Cryptocurrency Tax liability automatically!!!
Check TokenTax out!
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