How is cryptocurrency taxed: The Complete Guide

One of the most important economic stories of the modern era is the alternative to traditional currencies. Commonly referred to as “crypto” and sometimes referred to as “digital currency”, its most popular examples are Bitcoin and Ethereum, but there are thousands of others. What is cryptocurrency, why do the authorities tax it, and how does it affect your financial situation?

Simply put, cryptography is a new kind of exchange represented by binary data owned by individuals. Confidential data is stored using highly secure cryptography (hence the name “crypto”) in a digital database. These records do three things. They track the transfer of ownership, control the issuance of new coins and ensure the complete security of all transaction records.

Even if this all sounds theoretical, the reality for the millions of cryptocurrency holders is that their alternative currency has real value, is taxed in many countries, and is treated as a major asset. But for tax purposes, they are subject to the rules on capital gains and losses. They can be spent like regular money and stored for long-term profit like stocks, and even mined (created) for profit. However, tax laws vary from country to country. Always consult a tax advisor to meet your legal obligations before risking crypto investments.

In this article, you will learn the basics of cryptocurrency taxation. However, you are advised to seek professional advice as the regulatory framework does not apply to all countries or jurisdictions.

What gives cryptocurrency value?

They say in economics that any form of currency derives its value from its utility 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). Cryptocurrency has both of these characteristics, which led to its popularity.

On the other hand, the value of cryptocurrency is not very stable like most traditional currencies. Think about the dollars you have in the 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 of the major cryptocurrencies. Cryptocurrency is volatile and fluctuates a lot compared to fiat currencies.

So while it is possible to say that a cryptocurrency has value based on being a medium of 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 likelihood that popular digital coins could rise in price dramatically is what keeps the niche so active and has led to the creation of so many crypto exchanges.

Why is cryptocurrency taxed?

Tax policies vary from country to country. The short answer to this question is that it all depends on where you are located, the type of digital assets you own, how long you own them, your profits and losses, and more.

For example, US law treats virtual currencies like bitcoin and others as underlying assets, just like the stocks or bonds you hold in a portfolio. And since bitcoins and altcoins are subject to capital gains and losses, you can tax them if you sell them for a higher price than you originally paid for them. But it may not be the same for countries like Russia, Singapore, Hong Kong and others. However, the rules change from time to time.

Of course, if you have to pay 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 level (and a few other factors). The current income tax rate on long-term capital gains is 0, 15, or 20 percent.

How are bitcoins and altcoins taxed?

The crypto tax rate is based on the following considerations: your income level; whether your transactions are capital gains or losses; determining whether losses or gains are long-term or short-term; whether you are doing cryptography as a hobby or as a business venture.

However, it is useful to remember that the vast majority of altcoin holders simply buy cryptocurrency and hold it, hoping to make a long-term profit.

There is another large group, namely cryptocurrency enthusiasts, who often trade various coins on major exchanges, hoping to make short-term profits.

Taxation of crypto capital gains against capital losses

Let's take the US taxation system as an example, the standard rule of capital loss and gain applies to crypto. In any given year, crypto investors must report any profits, both long-term and short-term, and pay tax on them at your specific rate. However, if an investor shows a loss, he or she can use up to $3,000 to offset exactly the same amount of ordinary income.

What to do if your losses exceed $3,000? In this case, you would use the first $3,000 to offset ordinary income for the current year, and the rest as a carry-forward loss, which may be net of capital gains in subsequent years, indefinitely until the loss is completely exhausted.

Capital gains tax developments

Regulators talk about "taxable events" or situations that give rise to tax liabilities for an individual taxpayer. So what are the tax developments with crypto?

As explained by US tax developments, you earn capital gains if you sell bitcoins or altcoins that someone gave you or that you previously purchased. Your backbone in a coin: its value at the time it was received or purchased.

Then when you sell the crypto you have to compare the cost with your base. If the sale price is higher, you make a profit, which is short-term or long-term, depending on the holding period. Up to one year of holding activates short-term profit or loss. More than one year results in long-term gains or losses.

Another way to make a profit is to spend crypto on goods or services. The Internal Revenue Service (IRS) treats this as a “sale” of the coin and bases the amount of the sale on the value of the cryptocurrency at the time of the sale. Suppose you bought one unit of ABC coin (a hypothetical cryptocoin) for $50 five years ago and held it until yesterday, then used it to buy camping equipment online for $200. In this case, you will register a long-term capital gain of $150 (i.e. $200-$500).

Likewise, if you mined one unit of ABC coin six months ago when the coin was worth $100 and recently sold it for $1,000, your short-term return on equity (less than a year) would be $900. If you are developing crypto as a business venture, you will also need to apply for these profits.

Tax events related to loss of capital

It is just as easy to incur losses on a sale or spend on crypto as it is to make a profit.

Is cryptocurrency taxable if it is used for retail spending?

The interpretation differs in different countries. While some countries consider that crypto spending is not taxable, but according to the rules of the tax office in Russia, crypto spending is the same as a sale, and they are taxed no matter how small the amount. Since the tax law classifies crypto as property, “spending is a sale”, and you must record the fair value of the coin when you spend it, compare that value with what it was worth when you purchased it, and report the gain or loss at deal.

Are crypto miners exempt from taxes?

Cryptodiners are not exempt from taxation in Russia. In fact, they must keep a careful record of all the coins they mine, the exact dates of the mining, and the exact value of the coins on the day they were mined. But miners who run a business can deduct normal expenses such as rent, electricity, and equipment if they can document specific expenses associated with the business operation.

People who only mine crypto as a hobby are subject to the same profit and loss reporting rules. Instead, amateurs report their profits and losses as ordinary income. However, they can only deduct losses from the hobby to the extent of the profits made.

In principle, there is no “carryover” of losses. If your mining hobby made $500 but had a mining loss of $700, you would report zero profit/loss from that hobby, not a loss of $200.

Final words

Everyone should know two things about cryptocurrency. First, its future value can rise or fall significantly, making it an attractive investment for those who expect its value to rise significantly. Secondly, no matter how you interact with crypto, there is a very high chance that you will experience capital gains, receive taxable income and pay taxes at some point in the future (unless you only have losses for your efforts). Of course, this also depends on where you are and whether the rules apply to you.

If you have a virtual currency - bitcoin or altcoins, there is a good chance that you will receive a capital gain or loss when you decide to sell or spend it. The main reason for this is that cryptocurrency is a major asset that creates a tax liability the minute you download it.

Keep in mind that you may owe crypto taxes even if you store and sell your crypto on one of the many crypto exchanges. Also, if you develop crypto as a business venture, you will end up with taxable income as a result of creating (mining) new coins. How much you end up owing the government will depend on your tax rate, how much you mined, and whether your business had any deductions for the year.

In almost every case, people who own cryptocurrencies are subject to tax liability in the form of capital gains tax and/or self-employment tax in the mining business. You are strongly advised to seek professional advice on how to calculate your tax bills, no matter what country you are in. If you try to avoid paying taxes, you will always be punished with financial penalties or worse. Please do your due diligence to comply with laws and regulations.