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The above article is intended to provide generalized financial information designed to educate a broad segment of the public it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
How Does The Irs Know About Your Crypto
The IRS uses a variety of tactics to detect cryptocurrency investments and unreported income. The most predominant of which is the 1099 reporting system.
Major exchanges like Coinbase, Gemini, Uphold, Kraken, and others report certain customer activity to the IRS using form 1099-K and/or other related 1099âs. These 1099âs all serve the same general purpose: to report non-employment related income to the IRS.
Both you and the IRS get sent a copy of these forms at year-end.
If the IRS receives a 1099 from your crypto exchange but sees no cryptocurrency income reported on your taxes, your account will be flagged and an automated CP2000 letterwill be sent alerting you of your non-reported income and tax liability.
You can learn more about how 1099-K works for your crypto exchange activity here.
Outside of 1099 reporting, the IRS works with blockchain analytics companies like Chainalysis to track cryptocurrency movements directly on-chain. Since 2015, the IRS has spent more than 10 million dollars on Chainalysis contracts. This data is used to identify tax fraud and money laundering.
The Superficial Loss Rule
The Superficial Loss Rule kicks in when both of these conditions are met:
- The taxpayer acquires cryptocurrency that is identical to the one that they dispose of, either 30 days before or after the disposal, and
- At the end of that period, the taxpayer or a person affiliated with the taxpayer owns or had a right to acquire the identical property.
What all this means is if you sell and buy assets of a similar kind within a 30 day period – you can’t offset these capital losses against your capital gains.
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How To Pay Tax On Cryptocurrency In Canada
The deadline to pay your taxes in Canada is the same day as the deadline to file – so the 30th of April 2022. This is why we recommend filing well ahead of the deadline to ensure you’re not stuck in the lurch with a large tax bill. Once you’ve filed the CRA will let you know how much tax you owe on your crypto and give you options for payment.
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Buying Crypto With Crypto
Buying crypto with another crypto is subject to Capital Gains Tax. The CRA view this as a disposal – you’re getting rid of one asset. It doesn’t matter that you’re using it to buy another – you’ve still disposed of your asset.
Let’s say you bought BTC with ETH. The CRA aren’t interest in you buying ETH, they’re interested in you selling Bitcoin. You need to calculate whether you have a capital gain or loss from your disposal of BTC. To do this, you’d use the cost base of your BTC from the day you bought/acquired it and subtract it from the fair market value of BTC in CAD on the day you swapped it for ETH.
Two Types Of Crypto Taxes: Capital Gain Vs Income
As mentioned earlier, cryptocurrencies are taxable and in the United States, and there are two types:
In the case of capital gains, the rates depend on the holding period and are classified as:
Here is a list of activities that fall under capital gains tax vs. income tax.
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Keeping Records Of Your Transactions
Many cryptocurrency exchanges have terrible records, so you shouldnt rely on them to get all of your trading history. Youre better off keeping a detailed summary of all the trades you make. Start a spreadsheet and start tracking the following:
- Transaction dates
- Buy, sell, and trade values
- Units bought, sound, or traded
When possible, youll also want to keep records of the following:
- Receipts of purchase
- Cryptocurrency addresses when trading with other individuals
- Exchange records
Basically, you want to keep as many detailed records as possible. Theres nothing illegal about owning or trading cryptocurrency, but the CRA wants their fair share of taxes. To calculate what you owe, youll need all of your records. Theyll also be handy if you ever get audited.
Should I Use An Accountant
If youre unsure about how to handle your taxes, speak to an accountant who has experience with cryptocurrencies who can guide you through the process or file your taxes on your behalf. That said, theyre still going to need some kind of paper trail to help you out.
Another solution is to try TurboTax Live Full Service since youll get access to a tax expert who can file on your behalf. You can ask them as many questions as you want and you only get charged when you actually file.
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How Is Margin Trading Taxed
Cryptocurrency exchanges like BitMex have popularized the use of margin trading. The IRS has not yet set forth explicit guidance on how cryptocurrency margin transactions should be handled from a tax perspective, but we can infer the likely treatment based on other guidance.
A margin trade consists of borrowing funds from an exchange to carry out a trade and repaying the loan afterwards. The conservative approach is to treat the borrowed funds as your own investment and pay capital gains tax on the margin trading profit and loss.
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What Are Capital Gains And Losses
In short, they’re the difference between how much an asset cost when you bought it and when you sold it. If the price went up, it’s a capital gain. If it went down, it’s a capital loss. The IRS has published a longer and much more detailed explanation.
The other thing to know about capital gains is that the IRS categorizes them as short-term or long-term. Generally, the proceeds associated with assets you held for more than 365 days would be classified as long-term capital gains, which are typically taxed at 15%. Any assets held for a shorter time are short-term gains, and taxed like ordinary income — at rates that can go as high as 37%.
This works both ways. If you lost money on your crypto-shenanigans last year, you can now deduct those losses on your return.
Trading Cryptocurrency In Your Tfsa And Rrsp
With any potential capital gain, investors will always try to shelter themselves from taxes. The next logical question people ask is can I trade cryptocurrency in my TFSA and RRSP?
No, you cant. Nor can you transfer any Bitcoins you currently have into your TFSA or RRSP. Cryptocurrencies operate on their own exchange which does not tie any accounts which are tax friendly. That said, there are now cryptocurrency ETFs that can be purchased within your TFSA or RRSP.
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How Are Crypto Donations Taxed
Donating your crypto is tax free and deductible as long as you are donating to a registered charity.
If you are claiming a deduction larger than $500, you will need to report this on Form 8283.
The amount of your donation that is tax deductible depends on how long you have held the assets:
- For crypto held for more than 1 year, you can deduct the cryptocurrencyâs fair market value
- For crypto held for less than a year, you can deduct whichever is lower: the cryptocurrencyâs fair market value or your cost basisâ
Virtual Transactions Bring Real
Bitcoin and several rival forms of cryptocurrency experienced record-breaking growth in recent years, leaving many investors and their CPAs grappling with uncertainty and surprise during tax season. Many returns were put on extension, awaiting further guidance from the IRS, while other taxpayers found themselves faced with an unexpectedly large tax bill as a result of misconceptions surrounding how these transactions are taxed.
Cryptocurrency is digital currency that uses encryption techniques, rather than a central bank, to generate, exchange, and transfer units of currency. Unlike cash transactions, no bank or government authority verifies the transfer of funds. Instead, these virtual transactions are recorded in a digitized public ledger called a blockchain. Individual units of the currency are called coins.
Introduced in 2009, Bitcoin was the first cryptocurrency and remains the most widely used. Other forms have grown tremendously in popularity since then, including Litecoin, Ethereum, and Ripple. While cryptocurrency exchanges have experienced booms and busts in the market, experts predict the use of cryptocurrency will continue to increase, making it imperative that CPAs are prepared to understand and educate their clients on the tax implications of these virtual transactions.
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Does Cryptocurrency Need To Be Reported On My Tax Return
a. Yes, cryptocurrency is taxable upon disposition. You need to track the value of your cryptocurrency in CAD when it is received and report that income on your return as you would any other business or investment transaction.
b. If you hold more than one type of cryptocurrency in a digital wallet, each type of cryptocurrency is considered to be a separate digital asset and must be valued separately. For example, a Bitcoin is valued separately from a Litecoin.
Is It Considered Business Income Or Capital Gains
a. Business income
i. The CRA describes signs of business activity as when you carry on the activity for commercial reasons, with business-level planning, and execution, with an intention to show a profit.
ii. Please note, even a single transaction could be considered an adventure in trade, and therefore business income, especially if the intention is to make a quick profit.
iii. Essentially, are you day trading? If so, its likely considered business income vs. a capital gain
b. Capital gain
i. If the sale of a Cryptocurrency does not involve any of the business process, then it is considered a capital gain. Only half of the capital gain is subject to tax. Any capital losses can be used to offset the capital gains.
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How Do I Report Transactions On Form 1099 On My Tax Return
If youâve received a Form 1099, itâs important to accurately report your cryptocurrency transactions on your taxes to avoid IRS scrutiny.
Remember, Form 1099 is not an âentry formâ, meaning you donât actually include it with your tax return. Instead, you use the information on the form to complete the relevant portion of your tax return.
The gains and losses reported on a 1099-B should be included on Form 8949 of your tax return. This form reports your total capital gains and losses from all of your investments. Once this form is complete, your net gain or loss should be reported on Schedule D.
The cryptocurrency income thatâs reported on a 1099-MISC should be reported on Schedule 1, Schedule B, or Schedule C of your tax return depending on the specifics of your situation.
We know all of this can get confusing. For more information, check out our step-by-step guide to reporting your cryptocurrency taxes.
Capital Gain & Loss On Crypto
A capital gain or loss is incurred on trading or selling cryptocurrency. Just like traditional assets, capital gains will be incurred when the price of selling is greater than the price it has been acquired for . On the other hand, a capital loss is incurred when the price of selling is lesser than the price it was acquired for.
Before selling a capital asset, you must figure out if the investment was short-term or long-term. Long-term gains and losses are incurred when the assets were held for more than a year, whereas short-term capital gains and losses are incurred when the assets have been held for less than one year.
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What Is Virtual Currency
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like real currency , but it does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as convertible virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
What Happens If You Dont Report Your Crypto Taxes
Intentionally not reporting your cryptocurrency gains, losses, and income on your taxes is considered tax fraud by the IRS.
The IRS can enforce a number of penalties for tax fraud, including criminal prosecution, five years in prison, along with a fine of up to $250,000.
Over the past two years, the IRS has aggressively been cracking down on cryptocurrency tax compliance. The agency has sent tens of thousands of warning and action letters to Coinbase users suspected of inaccurate tax reporting. It has also to include a question that every US taxpayer must answer under penalty of perjury:
âAt any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?â
With this much scrutiny on the cryptocurrency asset class, itâs likely that we will see audits and criminal tax prosecutions continue to increase as cryptocurrency and bitcoin adoption accelerates.
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If Classified Under Capital Gains :
If the crypto-transactions are classified as investments, they will be considered capital gains or losses under the head capital gain.
If the sale value of the transaction is more than the cost, it will be regarded as capital gain, and if the price is higher than the sale value, it will be considered capital losses.
As per the applicable income tax slabs, short-term capital gains tax will be leviable if crypto assets are held for less than three years . If the crypto-assets are sold after holding the investment for three years , they will be treated as long-term investments and taxed at 20% with indexation benefit.
Crypto Miners May Be Treated Differently From Others
Do you mine cryptocurrency as a business? Then you might be able to deduct your expenses, as a typical business would. Your revenue is the value of what you produce.
If you mine cryptocurrency, you realize income at the fair market value, so thats your basis in the cryptocurrency, says Harris. If this is a trade or business, your expenses may be deductible.
But that last bit is the key point: You have to be running a trade or business to qualify. You cant operate your mining rig as a hobby and enjoy the same deductions as an actual business.
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