Cryptocurrencies have been in a bull market unlike we’ve seen anything so far. So, it’s only natural that we hear questions like “Is cryptocurrency taxable?” Remember what Benjamin Franklin said? “Nothing can be said to be certain, except death and taxes.”
That should probably answer the question for you. Yes, if you are among those who made money off cryptocurrencies, you owe Uncle Sam (or your own government) a part of the proceeds. In fact, the recent tax code signed into effect by President Donald Trump on 22th Dec clearly defines cryptocurrency as a taxable digital commodity.
Is Cryptocurrency Taxable?
All forms of income are taxable in almost every jurisdiction around the world unless there are specific exemptions forgoing taxes on certain incomes or gains. Basically, the question of “Is cryptocurrency taxable?” is somewhat redundant. The real question should be, “How are gains from cryptocurrency treated under the current tax code and what the effective tax rate would be?”
Recent Changes to the Tax Code
Let’s first look at the recent changes to the tax code and how it affects gains from cryptocurrencies. This is probably what most people who made money from cryptocurrencies are wondering about. After that, we can look at some of the more general aspects of taxation in the context of cryptocurrencies and digital assets.
First of all, it is important to note that you always had to pay taxes on the gains you made on cryptocurrency. Even before the recent changes to the tax code, you still had to pay taxes if you profited off cryptocurrencies. The recent changes to the tax code deal with the specific aspect of cryptocurrency.
Let’s see what the changes are:
Prior to the recent changes in the tax code, there was a loophole in the tax code called, like-kind exemption. The exemption was written into the tax code intentionally for traders to exchange certain assets such as real estate or art without having to pay taxes on the transaction.
However, when the exemption was written into the tax code, bitcoin had yet to become a market in its own right. This is why cryptocurrencies were not listed with other frequently traded assets like stocks and bonds. You have to pay taxes on the value of the transactions involving stocks and bonds.
But since cryptocurrencies were treated as property instead of currency, cryptocurrency investors used the loophole to avoid paying taxes on cryptocurrency transactions on trading exchanges.
The change to the tax code addresses this loophole, meaning, if you’re a cryptocurrency trader, you will now have to pay taxes on each and every trade you make involving cryptocurrencies. But it doesn’t really mean that you will literally have to send the government a cheque for every transaction. The exchange will charge you for every transaction along with its transaction fee and pay it on your behalf as most stock, commodities and forex exchanges do.
Tax Particulars on Cryptocurrency Transactions
- Similar to stock trading, trading cryptocurrencies can result in capital gains and losses, where you can use the losses to offset previous gains to lower your forthcoming tax bill.
- Exchange of cryptocurrency, meaning, exchanging bitcoin for ether or dash will also be considered as capital gains or losses.
- Simply receiving cryptocurrency as payment will be viewed as income and hence, taxed as ordinary income tax in terms of its fair market value at the time of the transaction.
- If you spend cryptocurrency to buy something, it will be considered as a taxable event; hence, generating capital gains or losses.
- If you mine cryptocurrency you will have to pay income tax on the value of the coins at the time it was mined at the fair market value. Similarly, if there are capital gains or losses after you’ve successfully mined them, it would be treated as a taxable event.
Understanding Basis, Gains, and Losses
The term basis is defined as the price you paid to acquire the cryptocurrency asset. The basis amount is used to determine capital gains or losses and the resulting taxation on the transaction. This is why it is extremely important for you to carefully record and track basis. Although you can get transaction history from all of the exchanges, you should still maintain your own records.
The reason you should maintain detailed records is that bitcoin is an investable asset, but unlike other investable assets like gold, stocks, property, etc. you can make everyday purchases with cryptocurrencies. You can’t do the same with gold or stocks.
Since cryptocurrency prices are extremely volatile, the chance of not generating a capital gain or loss is next to impossible. Even if you spend the cryptocurrency immediately after you bought it, chances are the price would not be the same when you spend it an hour or so later.
Because of this, every purchase will involve a taxable event, which will require you to determine the basis and record it. Even professional accountants don’t go to such lengths for their personal finances.
So every time you make a purchase and generate a capital gains, you have to pay capital gains tax on those gains. The problem is if you incur a loss on such a transaction, you can’t deduct the loss from such transactions. Losses cannot be deducted on such transactions. You can only deduct losses for trades, business transactions and transactions undertaken for profit-making.
This way, you might have capital gains of about 10% in a fiscal year but end up owing 15% in capital gains because you couldn’t deduct the losses you incurred after the gains. Indeed, it’s horrifying.
How Much are the Taxes?
As with everything else involving taxes, even providing a rough estimate of your potential tax bill is extremely difficult and cumbersome. So we will just cover some of the things you should know.
There are a number of tax brackets in the US tax code, so the amount of money you make will affect the tax rate that is applicable to you. Furthermore, unearned income, such as gains on cryptocurrency, is also subject to taxes that other forms of incomes and gains are not.
As you can see, there is no avoiding the taxman. Cryptocurrency or not, big brother expects his cut. Otherwise, you will find yourself on the wrong side of the law. Dealing with taxes is a headache, to begin with, and cryptocurrencies really add another dimension to the complexity.
The important thing to remember is that cryptocurrencies are taxable and you should maintain detailed records of your cryptocurrency transactions in case you need to deduct previous gains from the current tax bill. And if you consider how quickly fortunes are made and lost in the crypto-markets, it seems best not to avoid the extra effort.