Want to save more taxes? Well, what cost basis accounting method you use determines your gains, which determines how much you pay in taxes. So naturally, you would wanna use a cost basis method that works in your favor.
The following is a small but comprehensive guide on the different cost basis accounting methods collected from different countries.
What is a Cost Basis?
In simple words, the cost basis is what you pay to acquire an asset. It could be the same as your purchase price or a little more than if you paid other costs like transaction fees. Acquisition cost is another that is used alternatively to cost basis.
How is it Used?
Cost basis can have many uses, but mostly, and especially in the context of cryptocurrency, it’s used to calculate capital gains (or losses).
Cost Basis – Selling Price (FMV) = Capital Gains
Different Cost Basis Accounting Methods
Average Cost Basis
Average cost basis, also known as the moving average method, is one of the most common and widely used accounting methods all around the globe.
To calculate your cost basis using the average cost basis method, you divide the total acquisition cost of all the units of a cryptocurrency you own by the number of units.
Total Acquisition Cost of All Units / Number of Units = Average Cost Basis
So, for example, suppose you bought 1 BTC in June for $1000, another in July for $3000 and another 4 in August for $8000.
In August, you sell 5 BTC for $7000. Now, to calculate the capital gain, you must know the cost basis.
Using the average cost basis method, it would be:
$1000 + $3000 + $8000 / 1+ 1+ 4 = $2000
Therefore, you’ll incur a loss of $3000 (5 x $2000 – $7000).
In some countries, you only calculate the acquisition cost of all units up until the time you sell one (or more than one). But in other countries, you must add up the total acquisition cost of all units during the entire tax year.
So, continuing the same example, if you bought another 3 BTC for $9000 the next month, September, your cost basis would now be
$1000 + $3000 + $8000 + $9000 / 1+ 1+ 4 + 3 = $3500
Therefore, now you’ll incur an even greater loss of $10,500 (5 x 3500 – $7000).
Make sure you know the specificity of this method in your country to accurately report your gains and losses.
First-in, First-out (FIFO)
First-in-first-out is pretty self-explanatory. Let’s take an example that we can use for the rest of the following methods.
Suppose you bought 1 BTC every month for four months. The first month you buy it for $2000, the second month you buy it for $4000 and then $6000 and $8000.
Now, you own 4 BTC. But in the fifth month, you decide to sell one. But how do you identify whether you’re selling Bitcoin bought in the first month, second month, third or fourth, as that will determine its cost basis?
Well, the first-in-first-out method suggests that the first unit to come will be the first to go. Therefore, the cost basis of your Bitcoin would be $2000.
Last-in, First-out (LIFO)
Last-in-first-out (LIFO) suggests that the last to come will be the first to go. Using this accounting method, the cost basis for Bitcoin in the last example would be $8000.
High-cost, First-out (HIFO)
High-Cost-first-out (HIFO) suggests that the unit with the highest cost will be the first to go. Using this accounting method, the cost basis for Bitcoin in the last example would be $8000.
Low-cost, First-out (LOFO)
Low-Cost-first-out (LIFO) suggests that the unit with the lowest cost will be the first to go. Using this accounting method, the cost basis for Bitcoin in the last example would be $2000.
Even though many countries don’t allow the loss/utilization cost basis method to calculate crypto taxes, while many haven’t clarified their stance on it, it’s still worth explaining.
In short, the loss/utilization cost allows you to realize the largest losses first (short-term losses are prioritized first) and the smallest losses last. Continuing it allows you to realize the lowest gains first and largest last.
In simple words, this method lets you pay the least capital gain tax in a year.
Specific Lot Identification (SLID)
As you can guess by the name, specific lot identification (SLID) allows you to specify which unit you’re selling. Of course, you must provide adequate supporting evidence for it. The specific lot identification (SLID) accounting method is easier to use for cryptocurrencies than for stocks and shares, thanks to transaction IDs.
You would need a crypto tax calculator like Bitcoin.Tax to keep track of all your transactions and automatically calculate cost basis based on your designated accounting method.