Crypto Tax Calculation 101: How To Calculate Crypto Taxes
Learn how crypto tax calculation works and how to use a cryptocurrency tax calculator to handle your crypto taxes.
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This article is part of TokenTax's Cryptocurrency Tax Guide.
The cryptocurrency taxes you’ll owe are calculated based on the capital gains or losses from your digital asset holdings of coins like bitcoin. You are taxed on any value that your crypto gains between when you acquire it and when you sell or exchange it. The accounting is the same as stock trades or the purchase and sale of a house.
To accurately compute your tax liability, you will need to track your tax lots. Tax lots entail the cost basis (the amount you originally paid for the crypto), the time held, and the price at which you traded away or sold the crypto.
You’ll need your transaction history in order to track your tax lots — this entails a full record of your transaction history for all years you’ve traded (in case cost bases are from past years). Additionally, for each sale, you will need the following information:
- Amount and currency of the coin or token sold
- Fiat value at time of acquisition
- Date of acquisition
- Fiat value at time of trade or sale
- Date of sale
It is very important to keep detailed records because trades are challenging to backfill, and any missing cost basis increases your tax liability. You can back-fill missing data from receipts and exchange transaction confirmation emails, but it is much simpler to back up your information from exchanges regularly. Keeping notes on special situations, such as lost coins and ICOs, will also help you fill out your tax forms.
Once you’ve assembled your full transaction history, you can start calculating your capital gains and losses. To illustrate the specific details of the calculation, let’s walk through some concrete examples of how to match up crypto trades.
If you bought bitcoin, traded short term for litecoin, and then sold that litecoin long term for fiat, your trades in chronological order would be as represented below. Your capital gains tax calculation will be split out between short-term and long-term trades held for a duration of less than a year or greater than a year, respectively.
- You bought 1 BTC for $8,000 (including fees), thus your cost basis for this lot of 1 BTC is $8,000.
- You sold this 1 BTC for $10,000 (including fees) worth of LTC the next day, thus the proceeds are $10,000.
- Subtract the cost basis of $8,000 from the proceeds of $10,000, and your gain is $2,000, that amount of which you are liable for short term capital gains tax on.
- More than a year later, you sold the $10,000 LTC for $11,000 (including fees) in dollars, thus the proceeds are $11,000.
- Similarly, subtract the cost basis of $10,000 from the proceeds of $11,000, and your gain is $1,000, that amount of which you are liable for long term capital gains tax on.
At its core, calculating crypto taxes is matching sales of crypto to their respective cost basis (the price originally paid for that crypto), and then calculating the gain or loss from this sale.
However, it gets a little trickier if you have multiple cost bases for a lot of crypto that you sell. For example, if you buy 1 BTC in 2016 for $1,000, and 1 BTC for $12,000 in 2017, and then sell 1 BTC in 2020 for $10,000 in 2020, which cost basis do you use?
Accounting methods like FIFO, LIFO, and Minimization determine which cost basis is used in the above case. FIFO (First in, first out) for example would choose the earlier BTC buy — 1 BTC for $1,000 in 2016 — as the cost basis for that sale in 2020, leading to a $9,000 profit.
Most of the time, an accounting method like described above will be required, as the divisible nature of crypto means that many sales will either need to choose from multiple cost bases, or a single sale can have multiple cost bases. In the case of the latter, one say would be split out into multiple lines on the 8949, each with a different cost basis and gain / loss calculation.
If you just have a few crypto trades overall, it may be easy to manually calculate the gain and loss for each sale during the tax year and then enter those on the Form 8949. However, if you used multiple exchanges, sold coins with multiple cost bases, and held positions over multiple years, you may find it easier to use a crypto tax calculator platform.
Crypto tax calculators work by aggregating your data and then automatically linking your cost bases to your sales, using accounting methods like FIFO or LIFO. They calculate your gains or losses and automatically populate tax reports with your data.
These are the steps you’d go through when using a bitcoin tax calculator:
- Import all your cryptocurrency exchange trade history, as well as any transactions made off-exchange.
- Verify that all historical data has been imported, and that your crypto taxes are calculated properly.
- Decide on an accounting method.
- Export your tax forms.
- Include your crypto taxes on your return!
Interested in using a calculator platform for your crypto taxes to automate the process? Read our article on crypto tax software to learn more.