Crypto Taxes Basics: Cost Basis, Wash Sales, and Recordkeeping

Important Disclaimer

This article provides educational information only. It is not tax advice. Crypto tax rules are complex and vary by jurisdiction. Consult a qualified tax professional or CPA familiar with cryptocurrency before filing your taxes.

How Crypto Is Taxed in the US

The IRS treats cryptocurrency as property, not currency. That means every time you trade, swap, or sell crypto, it's a taxable event. You're either realizing a gain or a loss.

Key principle: You only pay taxes on realized gains (when you sell, trade, or spend crypto). Holding crypto doesn't create a tax liability.

Understanding Cost Basis

Cost basis is what you originally paid for your crypto. When you sell or trade it, you calculate gain or loss by comparing the sale price to your cost basis.

Simple Example

You buy 1 ETH for $2,000. Your cost basis is $2,000 per ETH.

Six months later, you sell that 1 ETH for $3,000. Your gain is: $3,000 - $2,000 = $1,000. You pay taxes on that $1,000 gain.

If you sold for $1,500 instead, you'd have a $500 loss, which can offset other gains.

Multiple Purchases

If you buy crypto at different times and prices, you need to decide which units you're selling. Example:

• Buy 1 ETH for $2,000 (January)
• Buy 1 ETH for $3,000 (June)
• Buy 1 ETH for $2,500 (October)
• You now have 3 ETH with different cost bases

When you sell 1 ETH for $3,500, which ETH are you selling? The answer depends on your accounting method.

Accounting Methods: FIFO vs Specific Identification

FIFO (First In, First Out)

FIFO assumes you're selling the oldest crypto first. In the example above, selling 1 ETH means selling the $2,000 ETH (January purchase).

Result: Cost basis = $2,000, gain = $3,500 - $2,000 = $1,500.

Pros: Simple, IRS default method

Cons: Less control over which lots you sell

Specific Identification

You choose which specific units you're selling. You must identify them at the time of sale (document which transaction IDs you're selling).

Example: You sell the $3,000 ETH (June purchase) instead of the $2,000 one. Cost basis = $3,000, gain = $3,500 - $3,000 = $500.

Pros: More control, can minimize taxes by selling higher-basis lots first

Cons: Requires detailed recordkeeping and documentation

LIFO (Last In, First Out)

Some tax software offers LIFO (last in, first out), but it's less common. Check with a tax professional before using LIFO, as it may not be acceptable in all cases.

Taxable Events

These actions trigger taxes (realize gains/losses):

Trading Crypto for Crypto

Swapping ETH for USDC, or any crypto-to-crypto trade, is a taxable event. You're selling one asset and buying another.

Example: Swap 1 ETH (cost basis $2,000) for 3,000 USDC (ETH worth $3,000 at time of swap). Gain = $3,000 - $2,000 = $1,000 taxable.

Selling Crypto for Fiat

Selling crypto for USD (or any fiat) is a taxable event. Gain or loss = sale price minus cost basis.

Spending Crypto

Using crypto to buy goods or services is a taxable event. You're effectively selling the crypto at its fair market value.

Example: Spend 0.1 ETH (cost basis $200) to buy a $300 item. Gain = $300 - $200 = $100 taxable.

Staking Rewards

Staking rewards are taxable as ordinary income when received. You also get a cost basis equal to the reward value at receipt. When you sell the reward, you calculate gain/loss from that basis.

Airdrops

Airdrops are taxable as ordinary income when received (at fair market value). If you later sell the airdropped tokens, you calculate gain/loss from the airdrop value.

DeFi Transactions

DeFi can create multiple taxable events:

• Lending: Interest earned is ordinary income
• Liquidity pools: Adding/removing liquidity can be taxable
• Yield farming: Rewards are ordinary income when received
• Liquidations: If collateral is liquidated, it's a sale

Non-Taxable Events

These don't trigger taxes:

• Buying crypto: No tax, you're establishing cost basis
• Holding crypto: No tax on unrealized gains
• Transferring to your own wallet: Moving crypto from one wallet you control to another you control isn't taxable
• Gifting crypto: Generally not taxable for the recipient (giver may have gift tax implications if over annual exclusion)

Wash Sale Rule

Important: As of 2024, the wash sale rule does NOT apply to cryptocurrency in the US (it only applies to stocks and securities). However, this may change in the future.

Wash sale rule (for stocks): You can't claim a loss if you buy substantially identical securities within 30 days before or after the sale. The loss is disallowed.

For crypto: You can sell at a loss, immediately buy back, and still claim the loss. However, watch for future rule changes. The IRS has proposed applying wash sale rules to crypto.

Capital Gains Tax Rates

Crypto gains are taxed as capital gains:

Short-Term (Held Less Than 1 Year)

Taxed as ordinary income (same as your income tax bracket). Rates: 10%, 12%, 22%, 24%, 32%, 35%, or 37% depending on income.

Long-Term (Held More Than 1 Year)

Taxed at preferential rates: 0%, 15%, or 20% depending on income. Most crypto investors qualify for 15% long-term capital gains rate.

Strategy: Hold crypto for more than a year before selling to qualify for lower long-term rates.

Recordkeeping Requirements

The IRS requires detailed records. Keep track of:

• All purchases: Date, amount, cost in USD, exchange or wallet address
• All sales/trades: Date, amount sold, sale price in USD, what you received
• Staking rewards: Date received, amount, value in USD at receipt
• Airdrops: Date received, amount, value in USD at receipt
• DeFi transactions: All swaps, LP additions/removals, rewards
• Transaction hashes: Keep blockchain transaction IDs for verification

Retention period: Keep records for at least 3 years after filing, longer if you claimed a loss (7 years).

Tax Software Tools

Manual tracking is nearly impossible for active traders. Use tax software that connects to exchanges and blockchains:

Koinly

Connects to exchanges and wallets, tracks DeFi, supports multiple cost basis methods. Pricing: Free for basic, $49-$199/year for tax reports.

CoinTracker

Similar to Koinly, good DeFi support, integrates with TurboTax. Pricing: Free for basic, $59-$199/year for tax reports.

ZenLedger

Another option with DeFi support and CPA review options. Pricing: $49-$249/year.

How They Work

1. Connect your exchange APIs or upload CSV files
2. Import wallet addresses (software reads on-chain transactions)
3. Software calculates gains/losses using your chosen accounting method
4. Generates Form 8949 and Schedule D for your tax return

Limitation: Software isn't perfect. Review calculations, especially for complex DeFi transactions. Always verify against your records.

Real-World Example: Tax Calculation

Scenario: You're an active trader throughout 2024.

• Buy 2 ETH for $4,000 total ($2,000 each) in January
• Stake ETH, earn 0.1 ETH rewards worth $300 in June (ordinary income = $300)
• Swap 1 ETH for 3,000 USDC in August (ETH worth $3,000). Gain = $3,000 - $2,000 = $1,000 (short-term, held 7 months)
• Buy 1 ETH for $2,500 in September
• Sell remaining 1.1 ETH for $3,500 in December (held 11 months, but using FIFO, you're selling January ETH + part of reward). Gain = varies based on allocation

Tax impact:

• $300 ordinary income from staking (taxed at your income bracket)
• $1,000 short-term capital gain from August swap (taxed at income bracket)
• Additional gains/losses from December sale

Use tax software to calculate exact amounts and generate forms.

Common Mistakes to Avoid

• Not tracking small trades: Every swap is taxable, even tiny amounts
• Forgetting DeFi: LP transactions, yield farming, lending all create taxable events
• Missing airdrops: Airdrops are income even if you don't claim them
• Not keeping records: IRS can audit and ask for documentation
• Assuming zero cost basis: If you received crypto as a gift or airdrop, your basis is the value when received, not zero

When to Consult a Tax Professional

Consider hiring a CPA or tax professional if:

• You have high transaction volume (hundreds of trades)
• You use complex DeFi strategies
• You're unsure about specific identification or accounting methods
• You received crypto from mining, staking, or airdrops
• You're dealing with multiple exchanges or wallets
• You have international tax considerations

Tax-Loss Harvesting

If you have unrealized losses, you can sell crypto to realize the loss, then buy back immediately (wash sale rule doesn't apply to crypto yet). This creates a tax deduction that offsets gains.

Example: You have $5,000 in unrealized losses. You sell to realize the loss, then buy back. You can use that $5,000 loss to offset $5,000 in gains from other trades.

Important: Only harvest losses if it makes sense for your strategy. Don't make trading decisions solely for tax reasons.

Resources

• IRS Notice 2014-21: IRS guidance on cryptocurrency taxation
• IRS Publication 544: Sales and other dispositions of assets
• Tax software: Koinly, CoinTracker, ZenLedger (compare features and pricing)