How to Calculate Taxes with Bitcoin Dollar-Cost Averaging?
31 Mar, 2023 · 4 min read
Bitcoin dollar-cost averaging (DCA) is one of the most popular investment strategies for beginner investors because of its simplicity, consistency-building pattern, and risk mitigation.
Today, we look into how employing Bitcoin DCA impacts the calculation of your gains and crypto taxes in the US. For clarification on your tax obligations as a crypto holder, check out our comprehensive guide about which crypto events are taxable.
What is dollar-cost averaging?
Dollar-cost averaging consists of investing a fixed amount (e.g., in USD/BTC) into an asset (e.g., Bitcoin) following consistent frequency (monthly, quarterly). If you plan to hold Bitcoin as a long-term investment, dollar-cost averaging may be an appealing option.
By doing it, you can build a position that has an averaged out price, which prevents drastic changes in the value of your portfolio amid volatile market cycles.
What is Bitcoin dollar-cost averaging?
Let’s imagine that you want to invest in Bitcoin and hold for ten years. You could invest 500$ each month for a couple of years without selling. As a result, you can build a significant Bitcoin position, gain exposure to potential gains, and offset risk due to the average purchase price you’ll get.
While you employ a Bitcoin dollar-cost averaging strategy, it would be advantageous to hold in the long-term and take advantage of a long-term capital gains tax setting. The same tax advantage is still applicable if you start divesting portions of your total position after holding for more than one year.
However, if you sell at different points in time, your gains calculation may seem more complicated at first due to the multiple entry prices. Let’s see how the accounting method you choose influences the amount you’ll pay.
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What is the best accounting method for Bitcoin DCA?
In the US, you can choose the accounting method (FIFO or specific identification). Once you make that decision, you will have to follow it in subsequent years.
If you start selling part of your position throughout time, your accounting method decision is particularly important as it will have a considerable impact on your capital gains tax bill. Let’s find out how.
Here’s how to calculate taxes with Bitcoin Dollar Cost Averaging.
In January 2020, Sarah started to invest by following a Bitcoin dollar-cost averaging strategy (regular purchases at different prices). She buys 0.1 BTC each month until December 2020.
These are the prices of Bitcoin when Sarah bought each month:
- January: $8,000
- February: $9,000
- March: $6,000
- April: $7,000
- May: $9,000
- June: $9,000
- July: $9,000
- August: $12,000
- September: $10,000
- October: $11,000
- November: $15,000
- December: $20,000
Sarah owns 1.2 BTC with an average purchase price of $10,416. Let’s imagine that Sarah wants to sell 25% of her total holdings after two years of holding (January 2022). Bitcoin price is now $70K. Sarah will be selling 0.3 BTC (25% of her holdings) for $21,000.
How much capital gains and taxes will Sarah have with Bitcoin DCA?
1. Using FIFO as the accounting method
FIFO is the default method favored by the IRS. When using FIFO (First-In, First-Out), Sarah’s basis cost will be the first purchases she made until the total amount purchased reaches the 25% of the holdings she is now selling.
2. Using HIFO as the accounting method
Using HIFO (Highest-In, First-Out), Sarah’s basis cost will be the highest purchases she made until the total amount purchased reaches the 25% that she is now selling.
Her basis cost will be the highest priced 0.3 BTC she purchased during 2020:
- August: 0.1 BTC at $12K/BTC ($1200 worth)
- November: 0.1 BTC at $15K/BTC ($1500 worth)
- December: 0.1 BTC at $20K/BTC ($2000 worth)
Capital gains = $21,000 – ($1200+$1500+$2000) = $16,300
Tax bill = $16,300 x 15% (long-term capital gain tax*) = $2,445
Using HIFO always reduces your tax bill, increasing the need for careful tax planning due to postponing higher tax bills.
*Long-term capital gains tax rates range from 0% to 20% in the US. We assume a 15% long-term capital gain tax for simplicity purposes. However, these rates are merely indicative as the real ones will depend on your total taxable income level, filing status (married/single), and many other factors as a US taxpayer.
A note on crypto taxes
We know crypto taxes can be confusing sometimes. We got you covered on all-tax topics from taxes on crypto trades to the tax implications of purchasing goods or services with Bitcoin. Take a look at the guides we put together with the best tools in crypto and all clarifications on crypto taxes:
- 2021’s NFT guide (with taxes)
- Tax implications of getting paid in crypto
- Crypto jobs: Here’s the 5 best platforms to find them
- Is transferring crypto between wallets a taxable event?
- 5 ways a Blockchain fork impacts your crypto taxes
*This post is part of the Crypto Taxes AMA series. Follow our weekly AMAs on Twitter where our expert CPA, Sharon Yip answers your crypto tax questions.
Learn how CoinTracking automatically calculates your unrealized and realized gains from Bitcoin dollar-cost averaging.
CoinTracking also helps you with:
- Importing your transactions (API & CSV) from 110+ exchanges/wallets
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- More than 25 reports, including which coins offer you a reduced tax rate
- Gains calculations according to 12 accounting methods (e.g., FIFO, LIFO, HMRC, ACB).
- Ready to-go Tax Reports in your country
If you need personalized help reviewing your transactions or preparing your US tax returns, check out our CoinTracking Full Service, provided by a team of crypto tax professionals led by Sharon Yip, the export CPA who helped us put together these insights.
Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.