Trading crypto? How to avoid a “nightmare” scenario at tax time
So you’ve been trading a new asset class called cryptocurrency.
It’s largely unregulated.
It’s a protest against “the man.”
It’s not centralized…
And you still have to pay your taxes.
Tax time is unpleasant for everyone, especially for people who do some trading, or a lot of it. So since tax season for 2018 is behind us, it’s a good time for cryptocurrency traders to start some good habits to make tax season next year a little less daunting.
The key to getting through tax season with a minimum of hassle and headaches is good record keeping.
Keeping track of your trading activities daily throughout the year is a lot easier and less stressful than waiting until the end of the year; then spending hours, or days going through months old records to get everything straight.
If you are keeping a trading diary as discussed in our article about managing trading risk, you are already on the right track. These records will not only help you at tax time but will also be part of your development as a trader.
NOTE: This article has been written in general terms and should be seen as broad guidance only. This article cannot be relied upon to cover specific situations that may be applicable to you and you should not act, or refrain from acting, upon the information contained in this article without obtaining specific professional advice tailored to your circumstances. Please contact your tax advisor or other qualified professional to discuss these matters in the context of your particular circumstances. Bitvo Global Inc., its affiliates, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it (in whole or in part).
Your cryptocurrency is considered a commodity
Now the first thing you need to understand is that the CRA has provided guidance that indicates Bitcoin and other cryptocurrencies are not classified as currencies by the CRA. They are considered commodities.
Regardless of how you receive or transfer your cryptocurrency asset, you need to track your entry and exit prices for tax purposes. This includes converting from one crypto coin to another.
Think of exchanging BTC for ETH as selling BTC and buying ETH for tax purposes.
The CRA also talks about receiving or exchanging cryptocurrencies as payment for services received, or services provided. In each case, recording the date and price of the “trade” on each side of the exchange is required.
So no matter how you receive or dispose of a cryptocurrency, it will have transaction entry and exit dates, entry and exit prices and some related fees.
The best way to keep track of these transactions is by using a simple spreadsheet or some software designed to track this information.
Entry, exit and fees
Let’s say you buy 1 BTC at $7,500 CDN on the Bitvo exchange.
Your transaction fee is 0.25% of the dollar value or $18.75 for the trade.
So your BTC purchase price is $7,500 + $18.75 = $7,518.75.
Now let’s say you nail a sell at $9,000 CDN. Bitvo’s fee for this transaction is the same at 0.25% or $22.50.
You take your exit price of $9,000 minus $22.50 which means you receive $8,977.50 CDN.
So your entry is $7,518.75, and your exit is 8,977.50 for a net capital gain of $1,458.75 CDN. Not bad!
What if you exchange one cryptocurrency for another one like some BTC for ETH?
On the day of the exchange, take the BTC price in CDN dollars and add it to your ledger as a sale. Take the ETH price in CDN dollars and treat it as the acquisition price and put that on your ledger as a buy. This way your figures are clear and easy to compare in one denomination, the one you will be calculating and paying your taxes in.
For example, let’s see your BTC entry price is $7,500 CDN (plus Bitvo exchange fee of 0.25%). Later when BTC is trading at a price of $9,494 CDN, you decide you want to exchange BTC into ETH, which at the time is $254 CDN, you would record:
Sale: 1 BTC $9,494 CDN. (minus trading fee if applicable)
Buy: 37.37 ETH $254 CDN. (plus fee if applicable)
Your BTC capital gain is $9,494 – $7,500 – $18.75 – (fees for the exchange if applicable) = $1,975.25.
Treat every transaction including coin to coin exchanges based on CDN dollar conversion (if you do trades out of country) to keep things easier.
At the end of the year, you calculate the net (gains minus losses) and subtract the fees, and that will give you your profit or loss for the period.
Obvious? Yes, but every year after months and sometimes hundreds or thousands of trades (potentially) this becomes a daunting task if you don’t get a handle on it from the beginning. Getting in the habit of writing these numbers down daily (or whenever you do a transaction) will save you a ton of time.
Every trader goes through this process regardless of the asset class.
What is your tax classification?
Let’s say you have all your records in order and you are ready for tax time. The next step is figuring out what your tax classification will be.
Are you a trader or an investor?
The CRA uses some specific language to explain the difference between these two designations. This has significant implications for your tax treatment and how your losses can be accounted for.
What’s the difference? Here are some of the considerations for classification by the CRA:
Duration: shorter term is considered trading.
Frequency: more frequent transactions are considered trading
Knowledge or expertise about Bitcoin markets can classify you as a trader
Trader: may already be classified as a trader for tax purposes in other asset classes
Time: how much of your time is spent on the activity, traders spend more time on the activity.
Now, for tax purposes, the designation of business (trader) or individual (investor) in CRA terms determines your tax rate and some details about losses.
Is your loss superficial?
For the CRA’s individual designation, you will have done few transactions, infrequently and spend little time on the activity. This also means that you need to be aware of how losses can and can’t be harvested.
Harvesting losses to offset portfolio gains is a strategy used by professional investors and savvy financial advisors all the time. This is typically done near the end of the year. When you see poor performing stocks getting blown out indiscriminately in November and December in the stock market, that’s the reason.
In crypto, this means disposing of a loser in your portfolio or taking a loss on some of your remaining holdings to offset taxable gains. But for those classified as individuals under the CRA, there are restrictions on this harvesting strategy.
You can’t lock in the loss with a sale and buy it back immediately. The loss is eligible for offsetting gains as long as you don’t buy it back after the sale for a defined period of time, usually 30 days.
For trader or business designation by the CRA, the rules for losses are different.
If you do a lot of transactions, have deep market knowledge and spend the majority of your time trading cryptocurrencies, it should be no surprise that you are going to be classified as a business (trader) by the CRA.
That means you will be taxed at your personal rate, so all gains will be taxed as regular income. The business designation also means you simply subtract your losses from your gains for your final taxable total, because there is no superficial loss rule for traders.
How much do I owe?
As a trader, your business classification means being taxed as straight income. So based on a previous example, if you are a business at tax time, your total gain of $1,458.75 will be taxed at whatever your personal rate is.
As an individual, infrequent trader or an investor your tax rate will be the capital gains rate of 50% of the capital gain. So instead of being taxed on the full capital gain of $1,458.75 you will only be taxed on $729.38. Which means in this example, individuals effectively get $729.38 in gains tax free. So a big difference.
Have a loss instead? Annual losses may be used to reduce future years gains (and taxes). Keep note of the loss and add it to your tax forms along with any trading gains you get in the years going forward.
Remember, the CRA will classify you based on how they see your activity, so if you say you are an investor when you are clearly a trader, you should be prepared to square up.
Not sure what you should be classified as? Call a tax professional or the CRA and get some direct guidance based on your situation.
The crypto area is an evolving space with periodic changes in regulatory and tax policy, so at tax time, consult the Canada Revenue Agency (CRA) website or your tax advisor for up to date guidance. Good records will make this process infinitely easier for you.
Bitvo is a state of the art cryptocurrency exchange founded by entrepreneurs with financial backgrounds. Bitvo provides cryptocurrency traders with the ability to manage their assets in and out of the network with the Bitvo Cash Card. Find out more here.