When determining how much tax you owe on Bitcoin and other Cryptocurrency transactions, cost basis is arguably the most important variable. Your gains and losses are all determined by comparing what you sell the asset for less your cost basis in the asset. Tracking your cost basis correctly is important to remain in compliance.

Let's start off with what cost basis is. Cost basis is the original value of an asset for tax purposes. Determining cost basis can be simple to complicated depending on the situation. Here are some of the most common situations:

• Buying Bitcoin with cash: This is the simplest transaction to determine cost basis. Your basis in the Bitcoin is how much cash you spent.
• Receiving Bitcoin for performing a service: Your basis in the Bitcoin is the value of the Bitcoin at the time you receive control of it. Example: If you agree to perform consulting work for 1 BTC on April 1 then on April 15 you complete the service and receive the payment on that date. If 1 BTC is worth $6,000 on April 1, but worth $5,500 on April 15 when you receive the Bitcoin, your basis is $5,500. It doesn't matter what Bitcoin was worth on April 1.
• Exchanging 1 BTC for 50 ETH: Your basis in the ETH is the cash value of 1 BTC on the date of transfer. The IRS views this transaction as a 2-step transaction. First you sold 1 BTC for cash (taxable event), then you bought 50 ETH with cash (not taxable). Because of this the basis in your ETH is the cash value of 1 BTC NOT the basis in your 1 BTC.
• My Cryptocurrency hard-forked and I received a new coin for no cost to me: Your cost basis is NOT $0 in the new coin. The fair value of the coin that you received on the date that you received and control it is your cost basis. The reason for this is that the IRS considers receiving a new coin as a result of a hardfork as a taxable event. You pay tax on the value of the coin when you receive it, so your basis is the amount that you paid tax on. This prevents you from being double taxed when you sell it. When you sell it, you are only taxed on the change in value of the asset from the date you received it.
• I received Bitcoin as a gift: This is probably the most complicated situation to determine your basis. The basis is different depending on whether you have a gain or loss when you sell it.
  • If you are selling the Bitcoin for a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift.
  • If you are selling the Bitcoin for a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift.
  • Example: You receive 1 BTC as a gift on April 1. On April 1, the BTC is worth $5,000. The person who gifted it to you, paid $4,000 for it and paid no gift tax. If you eventually sell the BTC for $6,000, your basis is $4,000. If you eventually sell the BTC for $4,500, your basis is $4,000. If you eventually sell the BTC for $3,000, your basis is $4,000.
  • Example 2: You receive 1 BTC as a gift on April 1. On April 1, the BTC is worth $4,000. The person who gifted it to you, paid $5,000 for it and paid no gift tax. If you eventually sell the BTC for $6,000, your basis is $5,000. If you sell the BTC for $4,500, your basis is $4,000. If you sell the BTC for $3,000, your basis is $4,000.