What is Crypto Tax and How is it Calculated?
With the rapid growth of crypto, especially in a time of increasing digitization, financial risk, and global economic inflations, countries are now trying to checkmate the burgeoning financial system through regulations and taxation.
The regulations are needed to ensure that crypto exchanges operate within the dictates of existing financial rules of their resident country. At the same time, taxes ensure that the government benefits from the billion-dollar market. Therefore, a global standard for crypto taxation is needed.
However, different countries' legislative arm and tax authorities have their own opinions on how they intend to take crypto taxes. Still, the generality of these countries accepts that digital currency is a means of payment or a medium of exchange. This means that the general legal status of cryptocurrency can be different across countries, but the modalities for taxing crypto are similar.
Thus, crypto users are expected to see crypto as a "store of value" that can appreciate or depreciate like stocks and bonds; they are also likely to see the different crypto taxation scenarios, the methods of its taxation, and the types of tax.
Since major cryptos like Bitcoin and Ethereum are “decentralized and anonymous,” how will the government impose taxes on such assets? Also, how is the calculation done?
Being a Store of Value, Crypto is Worth the Attention
The term "store of value" is used on anything that has the potential to either appreciate or depreciate over time. It is an asset subject to inflation dictates and other economic indices like purchasing power, time value of money, and market forces.
Crypto pioneer currency like Bitcoin is seen today as a “store of value” because its supply is pegged at 21 million coins; this limited supply makes it a store of value that can be taxed or used for savings and investment.
For cryptocurrencies like Ethereum with no pegged supply like Bitcoin, its store of the value potential is driven by its footprint in the Defi landscape and its practical uses cases in web3-based innovations; the foundation for ETH's potential to develop into a fantastic store of value is laid forth by its intrinsic value and the well-known deflationary EIP1559.
While it's possible to divide a dollar into 100 cents, a Bitcoin as of today can be divided into 100 million Satoshi. The same is true for dividing one Ether into one billion Gwei and one billion Wei from each Gwei.
Geographical barriers limit fiat currencies like dollars, pounds, and euros; crypto has no borders because of its on-chain-based transaction. The flexibility in using crypto for transactions anywhere in the world makes a veritable store of value.
Also, the centralized system assigns account owners' physical currency as a sign of ownership to their money. The crypto space has no centralized authority doing that, "you're your own bank," you could hold this cryptocurrency as your store of value for as long as possible.
Cryptocurrency Taxation and What the Government Thinks About It
Having established crypto as a store of value, I also need to espouse crypto taxation and the possibilities around its adventure.
Crypto taxation is the dynamic deductions that come with using crypto to facilitate transactions that bring profit. This is why taxpayers are expected to report any form of payments, crypto sales, or conversions to the IRS or other state authorities. For countries like the United States, every transaction has different tax implications.
Today, Cryptocurrencies in major countries of the world are regarded as assets and classified in the same categories as stocks, bonds, and other types of assets. The tax implications deductions rate on money gained from crypto-related transactions is subject to either capital gain tax or income depending on the duration you've held the crypto or the means through which you got the crypto.
Although, when it comes to crypto tax, it is vital always to know if what you use your crypto for is a "taxable event" or a "non-taxable event."
Government Will Likely Impose Taxes When…
Converting from crypto to crypto — Conversion from one crypto to another implies a sale because it exchanges for value and can be taxed as capital gains.
Conversion from crypto to cash — If you sell your assets for more than you purchased for them, you'll be required to pay taxes. You can write off any losses from sales at a loss when filing your taxes.
Crypto as a means of payment — Using your crypto to purchase goods and services directly attracts tax because spending crypto and selling it isn't much different.
Crypto mining — Based on the going fair market value (typically the price) of the mined coins at the time they were received, you will owe taxes on your gains if you mined cryptocurrency. Cryptocurrency mining profits are taxed as self-employment income.
Crypto hard fork proceeds — Taxes on crypto hard fork proceeds are mostly subjective because they depend on the exchange modalities for withdrawal and how the asset was used.
Getting wages/salaries in crypto — Every salary or wage earned through crypto is taxed accordingly, depending on countries' available income tax brackets.
Getting crypto incentives and rewards — Affiliate rewards like referral, bounty, learning and other incentives can be taxed because they're income.
Earnings of staking — Taxes on dividends from staking are calculated based on the fair market value of your rewards as of the day you got them, just like they are for mining proceeds.
Earned derivative interest — Derivative interests are earned when holding USDN stablecoins gives you interest in waves token; the accumulated interest in waves can be taxed.
Crypto Airdrop earnings — Proceeds obtained from engaging in Airdrop are also taxable.
Government Will Likely Not Impose Taxes On…
Intra Crypto transfers — Crypto transfers from one account to another owned by the same user cannot be subjected to tax since its owned by the same person.
Crypto got or received as a gift — A crypto as a gift cannot be taxed until the recipient decides to use the crypto for another transaction.
Buying to hold — Crypto purchased with cash for HOLDING cannot be subjected to tax until it appreciates.
Crypto donated to Charity — Any crypto given or received for charity will not be taxed.
Types of Crypto Currency Taxation
Crypto gain and income tax are the two main types of crypto tax; however, determining which to use is called cost basis.
Capital Gain Tax
Categorizes crypto in the same group with assets like bonds and stock, which can be taxed depending on the holding period.
Short-term capital gain tax — Are taxes on crypto assets held for less than a year, and the tax rate for most countries ranges from 10% to 37 %, respectively?
Long-term Capital gain tax — For crypto held for more than a year or more, the tax rate for most countries ranges from 0% to 20%, respectively.
- Examples of Capital gain activities
- Trading crypto for another crypto
- Purchase of goods and services using crypto
- Exchanging crypto for fiat
- Analysis of Crypto gains tax
- On the 15th of December 2021, you purchased 1 BNB for $600 (including fees); thus, your cost basis for this lot of 1 BNB is $600.
- On the 17th of December 2021, you sold this 1 BNB for $800 (including fees) worth of ADA.
- Subtract the cost basis of $600 from the proceeds of $800, and your gain is $200.
This amount is subject to short-term capital gains tax and will be recorded in your 2021 tax returns.
More than a year later 2023, you decided to sell the $800 of ADA for $1,500 (including fees) in BUSD.
- Subtract the basis cost of $800 from the proceeds of $1,500, and your gain is $700.
- The $700 is subject to long-term capital gains tax, which will be recorded as your tax returns for 2023.
Crypto activities like Airdrops, mining, staking, and other forms of interest-earning activity in the crypto space will be subjected to tax.
Other crypto activities that can be subject to income tax include:
- Crypto received a reward for engaging in play-to-earn games
- Crypto DeFi lending
- Crypto rewards from hackathons or bounty campaigns
- Crypto got from Minting or creating NFTs
How to calculate Crypto tax
Successfully calculating the crypto tax accrued to your crypto asset requires proper understanding and adherence to steps such as:
1. First, track all your crypto transactions
Tracking transactions requires you to know your tax lots for every crypto transaction you've carried out; a tax lot must contain information like the date of transaction, amount of crypto involved, and spot value at the time of trade/sale.
Becoming very good at determining your tax lot requires proper record keeping; you can use outstanding crypto tax software to help you with the record keeping.
2. Find your base cost
This is a critical aspect in the determination of your crypto tax obligation. Base cost refers to the "pure value" of your asset available for taxation.
Base cost is a major determinant of capital gain or loss, which is why it is calculated as proceeds - base cost = capital gains or loss.
However, it is also essential to know that transaction fees or crypto tax accounting methods can affect your base cost.
Crypto Tax Accounting Methods
The choice of accounting method is often determined annually by the country's tax authorities; the three most popular methods are HIFO, LIFO, and FIFO.
HIFO means Highest price assets are sold first; LIFO means Last in, first out; and FIFO means Assets acquired first are sold first.
Below is an analysis of how crypto tax accounting methods affect the base cost.
- Assuming you have 3 BNB in your wallet.
- 1 BNB was purchased in 2019 for $100;
- 1 BNB was purchased for $12,000 in 2021;
- While the last BNB was purchased for $4,000 in 2023.
- In 2023, you decide to sell 1 BNB for $6,000…
- If you choose LIFO, your capital gain will be $2,000 ($6,000-$4000)
- If you choose FIFO, your capital gain will be $5,900 ($6,000-$100)
- If you choose HIFO, you will have a capital loss of $6,000 ($6,000-$12,000)
On the other hand, the illustration below shows how transaction fees determine base cost.
To swap 400 USDT for 1BNB on pankcakeswap, you had to pay a $2 fee. You can add that $2 to the BNB's base cost, making it $402.
The evolution of blockchain and the adoption of its currencies have geared up calls for the government tax authorities to create modalities for crypto taxation and ensure taxpayers understand how and when to pay tax.
This article is one of the very many attempts aimed at simplifying the concept of crypto as a store of value, crypto as an asset that can be taxed, the do's and don't of crypto taxation, types of crypto taxation, and then the different methods of carrying out crypto tax calculations without stress.
If you've owned crypto for over a year before exchanging or selling it, your profit will be subjected to long-term capital gains. On the other hand, if you've owned crypto for less than a year before selling or exchanging it, your profit will be subjected to Short-term capital gains.
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