One of the most important economic stories of the modern era is the alternative to traditional currencies. Commonly called “crypto” and sometimes referred to as “digital currency,” its most popular examples are Bitcoin and Ether, but there are thousands of others. What is a cryptocurrency, why do authorities tax it, and how does it figure into your financial situation?
Simply put, crypto is a new kind of medium of exchange represented by binary data that is owned by individuals. The sensitive data is stored via high-security cryptography (hence the name “crypto”) in a digital database. These records do three things. They keep track of ownership transfers, control the issuance of new coins and operate to keep all the transaction records fully secure.
Even if all of that sounds theoretical, the reality for millions of crypto owners is that their alternative currency has real value; is taxable in many countries and is treated as a capital asset. But they are subjected to capital gains and capital loss rules for purposes of taxation. It can be spent like regular money and held for long-term gains, just as stocks; and is even mined (created) for profit. Still, the taxation regulations vary from one country to another. Always consult a tax advisor to fulfill your legal obligations before venturing into crypto investments.
In this article, you will learn the fundamentals of crypto taxation. But, we advise you to seek professional advice as the regulatory framework does not apply to all countries or jurisdictions.
What Gives Cryptocurrency Value?
In economics, it’s said that any form of currency gets its value from usefulness as a form of exchange (you can spend it) and from the fact that it can be used as a store of value (you can save it for future use). Crypto possesses both of those characteristics, which gave rise to its popularity.
On the downside, crypto’s value isn’t very stable, as those of most traditional currencies are. Think of the dollars you have in a bank. The only change in their value over the long term is the decrease caused by inflation. For comparison, look at the day-to-day value of any of the major cryptocurrencies. Crypto is volatile and fluctuates wildly by comparison to fiat currencies.
So, while crypto can be said to have worth based on being a vehicle for exchange and a store of value, it is impossible to say how much your Bitcoin or Ether will be worth tomorrow. For many investors, traders and hodlers, the chance that the popular digital coins can surge in price is what keeps the niche so active — and has caused the creation of so many crypto exchanges.
Why Is Cryptocurrency Taxable?
The taxation policies differ from one country to another. A short answer to this question is it all depends on where your location is, the type of digital assets you’re holding, how long have you been holding on to it, your profit and losses, and among the rest.
For example, the U.S. law deems virtual currencies like Bitcoin and others as capital assets, just like stocks or bonds you hold in a portfolio. And because Bitcoin and altcoins are subject to capital gains and capital losses, you can owe tax on them if you sell them for a higher price than what you initially paid for them. But it might not be the same case for countries like Singapore, Hong Kong, and more. Still, the regulations are subjected to change from time to time.
Of course, if you do owe taxes on your crypto, 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, based on income bracket, is either 0, 15, or 20 percent.
How Are Bitcoin and Altcoins Taxed?
The tax rate for crypto is based on the following considerations: your income bracket; whether your transactions are capital gains or losses; determining if the losses or gains are long-term or short-term; and whether you mine crypto as a hobby, or as a business venture. However, it helps to remember that the vast majority of altcoin owners simply purchase cryptocurrency and hold it, hoping to realize long-term gains.
There is another large group, namely cryptocurrency enthusiasts who frequently trade different coins on the large exchanges, hoping to earn short-term profits.
Crypto Capital Gains vs. Capital Loss Taxation
Let’s take the U.S. taxation framework as an example, the standard capital loss and capital gain rule apply to crypto; in any year, crypto investors must report any gains as either long-term or short-term and pay tax on them at your particular rate. However, if the investor shows a loss, then he or she can use up to $3,000 to offset the exact same amount of ordinary income.
What if your losses are greater than $3,000? In that case, you would use the first $3,000 to offset the current year’s ordinary income and the rest as a carry-forward loss that can be netted against future years’ capital gains, indefinitely until the loss is fully exhausted.
Capital Gains Tax Events
Regulators speak of “taxable events,” or situations that trigger a tax liability for an individual taxpayer. So, what are tax events with crypto?
According to the explained taxation events in the U.S., you incur a capital gain if you sell Bitcoin or altcoins that someone has gifted to you, or that you’ve previously purchased. Your basis in the coin is its value at the time you received or purchased it.
Then, when you sell the crypto, you have to compare the value to your basis. If the sale price is higher, you incur a gain that’s either short- or long-term, depending on the holding period. Up to one year of holding triggers a short-term gain or loss. More than one year triggers a long-term gain or loss.
Another way to notch a gain is to spend crypto on goods or services. The Internal Revenue Service (IRS) views this as a “sale” of the coin — and bases the sales amount on the value of the crypto at the time of sale. Say that you bought one unit of ABC coin (a hypothetical crypto coin) for $50 five years ago, and held it until yesterday, at which time you used it to buy camping equipment online for $200. In that case, you’d log a long-term capital gain of $150 (i.e., $200 − $50).
Likewise, if you had mined one unit of ABC coin six months ago when the value of the coin was $100, and recently sold it for $1,000, your short-term capital gain (less than a year) would be $900. If you mine crypto as a business venture, you would also need to file in for that gain.
Capital Loss Tax Events
It’s just as easy to incur losses on the sale or spending of crypto as it is to make gains.
Is Crypto Taxable If Used for Retail Spending?
The interpretation differs from one country to another. While some countries believe spending crypto is not a taxable event but according to IRS rules in the U.S., spending crypto is just like selling it and are subject to tax consequences regardless of how small is the amount. Because tax law classifies crypto as property, “spending is selling,” and you must record the fair value of the coin when you spend it, compare that value to what it was worth when you acquired it, and report either a gain or loss on the transaction.
Are Crypto Miners Exempt from Taxes?
Crypto miners are not exempt from taxation in the U.S. In fact, they have to keep meticulous records of all the coins they mine, the precise dates of mining, and the exact values of the coins on the day they were mined. But miners who operate a business can deduct ordinary expenses like rent, electricity and equipment as long as they can document the specific expenses connected to the business operation.
People who mine crypto only as a hobby are subject to all the same rules of gain and loss reporting. Instead, hobbyists report their gains and losses as ordinary income. However, they can deduct hobby losses only to the extent of gains acquired.
Basically, there is no “carryover” of losses. If your mining hobby brought in $500 but you had mining losses of $700, you would report a zero gain/loss from the hobby, not a $200 loss.
The Bottom Line
Everyone needs to know two things about cryptocurrency. One, its future value could rise or fall considerably, which makes it an attractive investment for those who believe its value will significantly appreciate. Two, no matter how you interact with crypto, there’s a very high probability you’ll encounter capital gains, have taxable income, and owe taxes at some point in the future (unless you have only losses to show for your efforts). Of course, it also depends on where you’re in and if the regulations apply to you.
If you own virtual currency — Bitcoin or altcoins — chances are that you’ll be subject to capital gains or loss when you decide to sell or spend it. The bottom-line reason for this is that cryptocurrency is a capital asset that creates a tax liability the minute you unload it.
Keep in mind that you might owe crypto taxes even if you store and sell your crypto on one of the many crypto exchanges. Plus, if you mine crypto as a business venture, you’ll end up having taxable income as a result of the creation (mining) of new coins. How much you end up owing the government will depend on your tax rate, how much you’ve mined, and whether your business venture had any deductions for the year.
In almost every case, people who own cryptocurrency incur a tax liability in the form of capital gains and/or self-employment tax on mining businesses. We strongly recommend you get professional advice to calculating your tax bills no matter in which country you are in. Should you attempt to evade tax, you’ll always end up with financial penalties or worse. Please use do your due diligence to comply with the laws and regulations.
This article should not be interpreted as tax or financial advice. Bybit advises users to seek professional advice when trading crypto and commodities as the regulatory framework for crypto taxation differs from one country to another. Users of this article agree that Bybit does not take responsibility for any of your investment decisions.