Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.
What Are Crypto Gains?
Crypto gains refer to the return crypto investors earn by buying and selling crypto assets. Gains are typically profits earned from trading but can also take the form of airdrops or earned interest from yield farming.
Why Is Calculating Your Crypto Gains Important?
It’s essential to calculate your crypto gains to measure the performance of your portfolio. If you don’t track your profits, you won’t get the complete picture of your trading strategy.
You must also keep accurate records of your crypto gains for tax purposes.
Understanding how to calculate your cost basis and profit is vital. If you’re trading on the blockchain, tracking these figures is not as simple as trading stocks on a regular brokerage.
Then you add crypto-specific transactions like airdrops and yield farming, adding another layer of complexity on top.
How Can You Calculate Crypto Gains? 4 Steps
It is always best to seek the advice of a CPA when doing your crypto taxes. However, a few steps can help you calculate your crypto gains.
Step 1. Track Your Crypto Transactions
Keeping track of your crypto transactions can take time and effort. Many blockchains, apps, and digital assets make up your crypto footprint. You will need to organize them all somehow to track your gains.
For on-chain transaction history, you can download CSVs from most block explorers. Of course, you’ll need to do this for all of your on-chain addresses.
For a payment blockchain like Bitcoin or Litecoin, it should be straightforward to download your transactions and keep them straight.
But for smart contract blockchains like Ethereum or Tron, you will probably need to separate your transaction history by token standards. In the case of ETH, you would download your fungible ERC-20 records separately from your non-fungible ERC-721s and ERC-1155s.
There are crypto tax services like Koinly or TokenTax that make this process slightly less painful for a fee. You can enter all your wallet addresses, and it will query and sort transactions for you and calculate tax burdens.
Either way, you go, querying yourself or using a service, you will likely get records that need “cleaning.” Meaning a token name didn’t come through cleanly, or you get a number with 100 decimal places that mess up your spreadsheet.
As weird as it might sound, most people should download their records sometime before tax season and poke around to see what they’re in for.
Crypto exchanges will also send you CSVs of your transactions and other pertinent tax forms each year. If you made trades on exchanges and on-chain, you might have to combine all the data into one spreadsheet to calculate your cost bases.
When you download exchange data, it typically includes the tokens you traded, amounts, dates, and market prices. This is the minimum you need to calculate your cost basis and taxes.
Some exchanges may send you your tax information without prompting, while others will need you to request it. It’s essential to stay on top of your exchange’s features.
Step 2. Find the Cost Basis
Crypto Accounting Methods
- FIFO (First In, First Out)
FIFO is a method for calculating the cost basis of tokens, assuming the first assets purchased are the first ones sold. Hence first in, first out. This is usually the simplest way to calculate cost basis.
The other benefit is that it can reduce capital gains. The long-term capital gains tax is much lower than the short-term rate.
Any asset held for over a year and then sold is subject to long-term capital gains tax. Depending on timing, FIFO might minimize your short-term capital gains.
According to CoinLedger (a crypto tax website), most investors use FIFO when filing. They describe FIFO as the most conservative method for doing your crypto taxes.
- LIFO (Last In, First Out)
LIFO is a method for calculating the cost basis of tokens, assuming the last assets purchased are the first ones sold.
LIFO is useful if the asset's price has fallen closer to or below your recent purchase price. This way, you minimize your gains or even book a loss on paper.
- HIFO (Highest In, First Out)
HIFO is when the highest-cost tokens are sold first. This may work out to a similar cost basis as LIFO. It benefits high-frequency traders with lots of trades.
You can reduce your taxable gains by deducting transaction fees in the United States. This includes blockchain fees sent to miners and trading fees.
Step 3. Determine Your Tax Rate for Capital Gains From Crypto
You should check the IRS guidelines for capital gains rates each year. Taxpayers under $500,000 income are taxed 15% on long-term capital gains and 22%-35% short-term, depending on income level.
Step 4. Calculate Your Gains
Using your chosen crypto accounting method, you should have your gains separated into short-term (less than one-year holding) vs. long-term. Next, apply the capital gains rates to your respective gains.
How Do You “Realize” Gains or Losses in Crypto?
Gains or losses are realized when you trade currencies on a crypto exchange or a blockchain. If you buy a cryptocurrency for $500, which goes up to $600, and sell, that’s a $100 gain.
Gains can also be triggered when you sell an NFT, receive an airdrop, or claim crypto yield.
If you receive an NFT, airdrop, or yield, it can be considered income by the IRS. When you cash out those assets, you then realize a capital gain.
How Can You Report Crypto Gains and Losses in Your Taxes?
The IRS form 1040 Schedule D is where taxpayers report their capital gains/losses. Certain exchanges and crypto accounting products will file on your behalf.
Usually, you will need to attach an addendum with your itemized trades and cost bases. But it’s always wise to double-check with a certified accountant before submitting your crypto gains to the IRS.
Using a Crypto Tax Calculator
Crypto tax calculators can take the stress out of your taxes. As mentioned before, there are paid services as well as free services.
The IRS only recognized crypto in 2014. So the crypto tax world is a new space. Even when using a calculator, you should triple-check the numbers to ensure you accurately report your taxes.
Because of the quirky nature of the blockchain, crypto tax software doesn’t always accurately catalog each transaction or token. Crypto taxes usually end up being a combination of automated tools and manual tweaks.
NFTs, Airdrops, and Other Scenarios
Calculating the cost basis of NFTs can be difficult. Typically the cost basis is what the collection’s floor price was valued at when you received the NFT.
If you’re minting the NFT, you could argue the cost basis is the mint price. But some might say the floor price or market price is how you should value the cost basis of your assets.
The IRS did release a draft statement this year saying NFTs would be considered ‘digital assets.’ NFTs are subject to capital gains and ordinary income tax.
Another tricky scenario might be when you trade NFTs. Many NFTs are collectibles, after all.
Say you have an NFT worth $200 and trade it for an NFT worth $250. Is this a capital gain? In this case, yes. You would have a gain of $250.
Airdrops are tokens you receive in your wallet for free. Usually, certain users are targeted for their on-chain activity. Airdrops can be used to reward users for completing specific tasks. Airdrops can also decentralize the token supply.
Airdrops happen on most significant blockchains. The most well-known airdrops have been on the Ethereum blockchain, but any chain with wallets and smart contracts can have them.
In the case of the Uniswap airdrop, anyone who had interacted with the decentralized exchange was airdropped 400 $UNI, which at its peak was worth more than $10,000.
A competitor called 1-Inch even dropped tokens to Uniswap users to entice them to use their product.
So if you receive an airdrop out of the blue, do you have to pay taxes on it? It depends.
Most airdrops are counted as income when received, and that’s where your cost basis starts. Then when you sell an airdrop, you trigger capital gains.
There can be exceptions where an airdrop isn’t counted as income. For example, scammers often send malicious tokens to wallets. The scam is to try to trick them into selling the tokens and signing faulty transactions that drain your tokens.
These can be considered spam emails where you “win” a gift card or cash prize. You wouldn’t consider that income. (Remember, the IRS doesn’t have clear guidance, so always double-check with your accountant.)
Yield farming is a DeFi (decentralized finance) mechanic popularized on the ETH blockchain in the summer of 2020. Users “stake” tokens in a smart contract in exchange for yield in the form of token emissions.
Yield farms are an alternative to ICOs (Initial Coin Offerings). ICOs are too similar to security offerings, so yield farms are a workaround.
Yield farming also incentivizes users to use liquidity or lend capital in exchange for interest.
Yield farming is a gray area for taxes. It is probably considered taxable income when you receive it and a capital gain when you exchange it.
The key is to stay consistent with how you treat different digital currencies.
NFT Sales and Royalties
How do you do your taxes as an NFT creator? Any income earned from primary or secondary sales is considered ordinary income.
Secondary sales of NFTs often have a built-in royalty that is automatically sent to the creator. These are usually between 1% and 10%. And since they’re programmatically enforced, royalties will keep coming in as long as the artist’s NFTs are traded.
For tax purposes, it’s a good idea for artists to create a standalone wallet just for royalties to keep track of the accounting.
The Bottom Line
Doing your crypto taxes can be downright scary. There is very little guidance from the IRS, and regulators seem suspicious of crypto users.
You must keep good transaction records to file your crypto taxes without hiccups. Most crypto transactions can be requested from your trading platform, mobile app, and blockchain explorer.
Once your transactions are logged in a spreadsheet, it’s time to calculate your tax basis. The options are First In, First Out (FIFO), Last In, First Out (LIFO), or Highest In, First Out (HIFO).
Then you should find your income tax rates and capital gains tax rates to determine your tax bill. Remember to subtract transaction fees from your taxable income.
If this sounds too complicated, you can use traditional CPA or crypto tax software like Koinly or TokenTax.
Whichever route you go, you should at least understand how your taxes are calculated. Smart traders understand that small trading decisions they make can reduce tax liability.
Tax loss harvesting is when one sells an asset at a low and immediately rebuys it to reduce taxable gains while remaining in an open position.
Taking profits in Bitcoin versus stablecoins can also make your tax accounting more complex. A remedy would be to exchange for stablecoins and then buy Bitcoin to make the accounting easier.
Whatever your tax strategy, we wish you the best of luck this season and urge you to dive into our blog and Youtube channel to learn more about crypto trading.
How Crypto Fees Can Lower Your Tax Bill | Koinly
Topic No. 409 Capital Gains and Losses | IRS
The Uniswap Airdrop - Lessons for the Industry | Uniswap
FIFO, LIFO, and HIFO - What’s the best method for crypto? | CoinLedger