One of the most important economic stories of the modern age is the alternative to traditional currencies. Often referred to as “crypto” and sometimes referred to as “digital currency,” the most popular examples are Bitcoin and Ethereum, but there are thousands more. What is cryptocurrency, why do authorities tax it and how does it affect your financial situation?
Simply put, crypto is a new type of medium of exchange represented by binary data owned by individuals. Sensitive data is stored in a digital database via high-security cryptography (hence the name “crypto”). These registers do three things. They track ownership transfers, control the minting of new coins and work to keep all transaction records completely secure.
While this all sounds theoretical, the reality for millions of crypto holders is that alternative currencies have real value; It is taxable in many countries and is considered a capital asset. However, they are subject to capital gains and capital loss rules for taxation purposes. Just like stocks, it can be spent like regular money and held for long-term gains; and even mined (created) for profit. Still, taxation regulations vary from one country to another. Always consult a tax advisor to meet your legal obligations before getting into crypto investments.
What Gives Cryptocurrency Value?
In economics, any currency is said to derive its value from its usefulness as a form of exchange (you can spend it) and its ability to be used as a store of value (you can store it for future use). Cryptocurrencies have both of these features that increase their popularity.
The downside is that like most traditional currencies, crypto’s value is not very stable. Think of the dollars you have in a bank. The only change in their value in the long run is the decline caused by inflation. For comparison, look at the daily value of any major cryptocurrency. Crypto is volatile and fluctuates wildly compared to fiat currencies.
So, while cryptocurrencies can be said to have value based on being a medium of exchange and a store of value, it is not possible to say how valuable your Bitcoin or Ether will be tomorrow. For many investors, traders and hodlers, the chance that the prices of popular digital currencies will rise is what keeps the niche so active and has led to the creation of so many crypto exchanges.
Why Is Cryptocurrency Taxable?
Taxation policies differ from one country to another. A short answer to this question is that it all depends on where you are, the type of digital assets you hold, how long you’ve held them, your profits and losses, and more.
For example, US law recognizes virtual currencies such as Bitcoin and others as capital assets, just like stocks or bonds you hold in a portfolio. And since Bitcoin and altcoins are subject to capital gains and capital losses, you may owe them taxes if you sell them for a higher price than you originally paid. But the same may not be the case for countries like Singapore, Hong Kong and more. However, regulations are subject to change from time to time.
Of course, if you owe taxes on your cryptocurrency, the amount you owe will depend on the size of your capital gains, as well as the tax rate you pay based on your income bracket (and a few other factors). The current tax rate on long-term capital gains is 0.15 or 20 percent by income bracket.
How Are Bitcoins and Altcoins Taxed?
The tax rate for crypto is based on: your income group; whether your transactions are a capital gain or loss; determining whether losses or gains are long-term or short-term; and whether you are mining crypto as a hobby or as a business venture. However, it is worth remembering that the vast majority of altcoin holders buy and hold the cryptocurrency in hopes of making long-term gains.
There is another large group, namely cryptocurrency enthusiasts who often trade different cryptocurrencies on major exchanges in hopes of making short-term profits.
Crypto Capital Gains and Capital Loss Taxation
Take the US taxation framework as an example, the standard capital loss and capital gain rule applies to crypto; In any given year, crypto investors must report any earnings long-term or short-term and pay taxes on them at the rate you specify. However, if the investor shows a loss, he can use up to $3,000 to offset the same amount of ordinary income.
What if your losses are more than $3,000? In this case, you use the first $3,000 to offset the current year’s ordinary income, and you use the remainder as a forward carrying loss that can be netted against future years’ capital gains indefinitely until the loss is fully exhausted.
Capital Gains Tax Events
Regulators refer to “taxable events” or situations that trigger tax liability for an individual taxpayer. So what are the tax implications with crypto?
According to the taxation facts disclosed in the US, you will earn capital gains if you sell Bitcoin or altcoins that someone gifted you or previously purchased. Your basis in cryptocurrency is its value at the time you buy or sell it.
Then, when you sell the crypto, you need to compare the value to your own basis. If the selling price is higher, you will make a short- or long-term gain, depending on the holding period. Holding up to one year triggers a short-term gain or loss. It triggers a long-term gain or loss of more than a year.
Another way to earn money is to spend cryptocurrencies on goods or services. The Internal Revenue Service (IRS) sees this as a “sale” of the cryptocurrency and bases the sale amount on the value of the crypto at the time of sale. Let’s say you bought a unit of ELES (a hypothetical cryptocurrency) for $50 five years ago and held it until yesterday, at the time you used it to buy camping gear online for $200. In this case, you would record a long-term capital gain of $150 (ie, $200 – $50).
Similarly, if you had issued one unit of ELES coin six months ago when the coin was worth $100 and recently sold it for $1,000, your short-term capital gain (less than a year) would have been $900. If you are crypto mining as a business venture, you must apply for this earnings.
Capital Loss Tax Cases
Losing money on selling or spending crypto is as easy as making a profit.
Is Crypto Taxable If Used For Retail Spending?
Interpretation differs from one country to another. While some countries believe that spending crypto is not a taxable event, but according to the IRS rules in ELES, spending crypto is just like selling it and is subject to tax consequences no matter how small the amount. Since tax law categorizes crypto as property, “spending is selling” and you should record the fair value of the coin you spent, compare that value to what it was worth when you received it, and report a gain or loss.
Are Crypto Miners Tax Free?
Crypto miners are not tax-free in the US, in fact, they are required to keep meticulous records of all the cryptocurrencies they mine, the exact dates of the mining and the exact values on the day the coins were mined. However, miners operating a business can deduct ordinary expenses such as rent, electricity and equipment as long as they can document certain expenses associated with the business activity.
Crypto mining-only hobbyists are subject to the same win and loss reporting rules. Instead, hobbyists report their gains and losses as ordinary income. However, they can only deduct hobby losses to the extent of gains.
Basically, there is no “taxation” of losses. If your mining hobby brought in $500 but you had a mining loss of $700, you report zero gain/loss from the hobby, not $200.
Final Words
Everyone needs to know two things about cryptocurrency. First, its future value can increase or decrease significantly, making it an attractive investment for those who believe its value will be significantly appreciated. Second, no matter how you interact with crypto, there is a very high probability that you will experience capital gains at some point in the future, have taxable income and owe taxes (unless you only have losses for your efforts). Of course, it also depends on where you are and whether the regulations apply to you.
If you have virtual currency (Bitcoin or altcoins), you will likely incur a capital gain or loss when you decide to sell or spend it. The main reason for this is that cryptocurrency is a capital asset that creates a tax liability as soon as you empty it.
Keep in mind that even if you store and sell your cryptos on one of the many crypto exchanges, you may owe crypto taxes. Also, if you mine crypto as a business venture, you will have taxable income as a result of the creation (mining) of new cryptocurrencies. How much you owe the government will depend on your tax rate, how much you mine, and whether your business venture has any deductions during the year.
In almost all cases, cryptocurrency holders incur a tax liability in the form of capital gains and/or self-employment tax in their mining businesses.
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