US Crypto Tax Cost Basis Methods [IRS 2024]

<div fs-richtext-component="info-box" class="info-box"><div class="flex-info-card"><img src="https://assets-global.website-files.com/65098a145ece52db42b9c274/650c6f4cef4c34160eab4440_Info.svg" loading="eager" width="64" height="64" alt="" class="icon-info-box"><div fs-richtext-component="info-box-text" class="info-box-content"><p class="color-neutral-800">Starting January 1, 2024, the Infrastructure Investment and Jobs Act requires reporting 10,000$+ crypto transactions to the IRS. Yet, the Treasury and IRS deferred digital asset reporting until new regulations are set, promising future guidance and public input on these rules. Stay informed: IRS</p></div></div></div>

The Principle Behind Cost Basis

In US crypto taxation, "cost basis" is the purchase price of your cryptocurrency, essential for calculating capital gains or losses.

A higher cost basis reduces capital gains, potentially lowering your tax bill, while a lower cost basis increases gains and taxes. Accurate tracking of cost basis is crucial for compliance and informed tax strategy.

Different methods, like FIFO, LIFO, HIFO, Specific Identification, and Weighted Average Cost, determine cost basis. These will be detailed in the article.

IRS's Perspective on Cost Basis Methods

The IRS treats cryptocurrency as property, similar to stocks or real estate, for capital gains and losses. While the IRS hasn't specified preferred cost basis methods for crypto, it emphasizes consistency and accuracy. 

<div fs-richtext-component="info-box" class="info-box warning"><div class="flex-info-card"><img src="https://assets-global.website-files.com/65098a145ece52db42b9c274/650c6f473e84badfdd6e059e_Care.svg" loading="eager" width="64" height="64" alt="" class="icon-info-box"><div fs-richtext-component="info-box-text" class="info-box-content"><p class="color-neutral-800">Once you choose a cost basis method, it's crucial to stick with it. Switching methods yearly can cause complications and increase the risk of errors or misreporting.</p></div></div></div>

Keep detailed records of all crypto transactions—dates, amounts, costs, and sales proceeds. Accurate tracking, especially for specific identification, is crucial. Tools like Blockpit's Crypto Tax Calculator can help. Inaccurate reporting can lead to penalties, interest, and audits. Properly calculate and report gains or losses to avoid issues.

Different Cost Basis Methods and Their Impact

First In, First Out (FIFO)

FIFO assumes the earliest purchased cryptocurrency is sold first. If you buy 1 Bitcoin in January at 30,000$ and another in June for 40,000$, then sell one in August, FIFO uses the 30,000$ cost basis.

Impact: Can benefit from lower long-term capital gains tax rates.

Usage: Common in consistent buying and selling scenarios.

Last In, First Out (LIFO)

LIFO assumes the most recently purchased cryptocurrency is sold first. If you buy 1 Bitcoin in January at 30,000$ and another in June for 40,000$, then sell one in August, LIFO uses the 40,000$ cost basis.

Impact: May lead to higher short-term gains in rising markets.

Usage: Suitable for rapid trading but can result in higher short-term taxes.

Highest In, First Out (HIFO)

HIFO selects the highest cost cryptocurrency units for sale first. If you bought Bitcoins at 20,000$, 30,000$, and 40,000$, selling one uses the 40,000$ cost basis.

Impact: Minimizes capital gains in rising markets.

Usage: Reduces taxes initially, but may increase future taxes. Requires thorough record-keeping.

Specific Identification (SpecID)

SpecID allows choosing the exact units sold based on their purchase details.

Impact: Provides flexibility to manage capital gains effectively.

Usage: Ideal for active trading, but requires meticulous documentation.

Weighted Average Cost

Averages the cost by dividing the total spent by the number of units. If you buy one Bitcoin at 30,000$ and another at 40,000$, the average cost is 35,000$.

Impact: Simplifies tracking, ideal for regular purchases.

Usage: Not suitable for volatile markets. Must be used consistently for each asset.

Example Calculation of Cost Basis Methods

• October 2023: Buy of 1 BTC for 30,000$
• December 2023: Buy of 2 BTC for 40,000$
• June 2024: Buy of 1 BTC for 60,000$
• December 2024: Sell of 1 BTC for 45,000$

*For the Weighted Average: You spent 170,000$ for 4 BTC, averaging 42,500$ per BTC.

For the December 2024 sale:

• FIFO: Report a gain of 15,000$
• LIFO or HIFO: Report a loss of 15,000$
• Weighted Average: Report a gain of 2,500$

Choosing the Right Cost Basis Method

Trading Habits: Active traders might prefer HIFO; occasional traders may opt for FIFO or LIFO.

Tax Implications: HIFO can reduce short-term taxes in rising markets but may impact future transactions. Consider both short-term and long-term capital gains rates.

Optimize & File Your Crypto Taxes With Blockpit

Blockpit creates the most comprehensive crypto tax reports in PDF format. The report provides information about all your balances and transactions and can be used as proof of origin with banks or tax advisors. It contains all relevant transactions of your account in the selected tax year and shows details such as timestamp, amount, asset, costs and fees of the individual transactions.

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Frequently Asked Questions

What is "cost basis" and why is it relevant for crypto taxation?

Cost basis is the original value of an asset for tax purposes, usually the purchase price. It determines the capital gain or loss when cryptocurrency is sold.

How does choosing different cost basis methods affect my reported capital gains or losses?

Different methods (FIFO, LIFO, HIFO) affect the order of sold coins, impacting gain or loss calculations and tax liability.

Are there specific cost basis methods that the IRS prefers or requires for cryptocurrency transactions?

The IRS hasn't endorsed specific methods, but favors consistency. FIFO is commonly used due to its simplicity.

Can I switch between cost basis methods from year to year as I report my crypto transactions?

Switching methods isn't explicitly prohibited, but can raise red flags. Consistency is recommended; consult a tax professional before changing methods.