Cryptocurrencies are digital assets that can be used as a medium of exchange to procure goods or receive services. The technology underpinning these digital assets is Blockchain. Blockchain is an ingenious piece of technology that uses strong cryptography to record and secure transaction data.
In a Blockchain, a number of transactions are clubbed together to create a block, this block is then immutably attached to another block using strong cryptography. The fact that these blocks are immutably attached to one another makes this an extremely secure system that has a low possibility of corruptibility. To alter a single transaction within a chain, all the proceeding blocks within the chain will need to be altered, this could be millions of individual transactions.
Due to the network’s resilience and reliability, cryptocurrencies have seriously disrupted the modern-day digital marketplace. There are a number of traits of these digital assets that make them an absolutely groundbreaking technology that will change the way we transact. Since they are going to change the way we transact and could very well become the globally accepted means of exchange, we need to figure out how they will be taxed.
What are Cryptocurrencies considered when it comes to tax?
Even though the word “currency” appears in cryptocurrencies or virtual currencies, they are considered property for Federal tax purposes. The general tax treatment of property is applicable to virtual currencies/cryptocurrencies.
The fact that cryptocurrencies are considered property for Federal tax purposes, any profits or gains you incur as a result of transacting in cryptocurrencies will be considered a capital gain, whether short or long term capital gains will depend on how long the cryptocurrency was held.
For example, if you buy yourself a new shirt using a cryptocurrency like Bitcoin which was trading at $100 when you bought it, you will need to account for the value of Bitcoin at the time you bought the shirt. Say Bitcoin was trading at $150 when you buy the shirt, you would’ve bought something that has a value in Dollars with an asset that increased in value itself. Since the value of your Bitcoin has appreciated and you have purchased a dollar-denominated product, the price you pay for the shirt will attract capital gains tax as well. Capital gains tax will be calculated on the $50 of profits you incurred.
One of the first things to know when it comes to crypto tax is, what are considered taxable events.
Buying FIAT currency using a cryptocurrency
Using cryptocurrencies as a mode of payment for goods or services
Trading in cryptocurrencies/Exchanging one cryptocurrency for another
Cryptocurrencies received through forks or mining activities
Using a FIAT currency to procure cryptocurrencies/virtual currencies.
Donations made to non-profit tax-exempt organizations in cryptocurrencies
Cryptocurrencies as gifts to third parties
The transfer of cryptocurrencies between wallets
Determining your Tax Liability
Exchanging Cryptocurrencies for FIAT currencies
When you exchange your cryptocurrency for a FIAT currency you will need to determine the purchase price of your cryptocurrency and the price at which you sold it. For example, if you bought a cryptocurrency for $300 and sold it for $500, the crypto tax will be levied on the gains of $200 you made on this transaction. These gains will be taxed under the head ‘capital gains’ and will be considered long-term or short-term depending on the duration for which the cryptocurrencies were held.
If it is a short-term capital gain your crypto tax will be added to your income tax, but if it is held for a period of more than 1 year it is considered long-term capital gains and will be taxed according to the appropriate tax bracket.
Long term capital gains for individuals whose income falls between the 10% – 15% income tax bracket is 0%, for individuals in the 25% – 35% income tax bracket long term capitals gains is taxed at 15%, and for income tax brackets higher than the 35% bracket long term capital gains are taxed at 20%.
Selling Mined Cryptocurrencies
As the use of your computer to mine cryptocurrencies is considered work, and the mined cryptocurrency is considered proof of work when you sell a cryptocurrency you have mined in exchange for dollars, it will be considered a business income.
When you use cryptocurrencies to make payments for daily purchases you will need to pay capital gains tax on the exchange rate. So you will need to account for the price you procured the cryptocurrency for and the price it was trading at when you made the purchase. If there were any gains in the value of your cryptocurrency at the time you make your purchase, you will need to pay capital gains tax based on the percentage of gains to the value of your purchase.
Trading in Cryptocurrencies
Most people are under the misconception that if you sell one cryptocurrency for another it is not considered a taxable event as they are what is known as a like-kind exchange, but this is not true. For example, if you exchange Bitcoin for some altcoin like Etherium, TRON, IoteX, etc., you will need to pay capital gains tax on the difference between the two cryptocurrencies. You can avoid this capital gains tax by selling your altcoins for a loss to offset the capital gains made from previous transactions before the end of the year.
Cryptocurrencies are poised to become the future of currency and they promise to bring a level of efficiency never before seen. The regulations surrounding crypto taxes are still a little murky but as time progresses and cryptocurrency are adopted more widely there will be greater clarity around crypto taxes. For now, we will need to depend on Crypto Tax Calculators and accountants to tell us our total tax liability when it comes to cryptocurrencies.