Oil and Water – The Question of Capital Gains Tax in the World of Cryptocurrency Trading
For any ardant stock trader or economically minded individual, capital gains tax is something that works alongside the world of conventional / traditional stock trading. For investors, they know exactly where they stand on what they gain versus what they owe in tax.
But that becomes a far more blurred line when we add the ecosystem of cryptocurrency to the mixture. What makes it an even bigger problem is when the trading volume moves from single digits to the thousands.
Since 2017, governments have been edging, at relative paces, towards implementing some kind of capital gains tax on anyone investing in cryptocurrency. Why 2017? Because that's when we truly saw cryptos hit the mainstream market before facing reversal.
The market cap, for example, exploded within this year, breaking past its collective $15 billion valuation, to exceed $600 billion in a very short span of time. Now, for everybody involved, including onlookers, it's safe to assume people now considered it a known and powerful quantity in the market. Those who were definitely not out of the loop were the government.
Speaking on behalf of the IRS' Criminal Enforcement Unit, Don Fort states that the world of “cryptocurrency is becoming a new area of enforcement for him.” In recent memory, the IRS pulled in Coinbase over its ongoing financial activity, demonstrating that the government was going to pull cryptocurrency into line somehow.
While stated against the wishes of the ‘founding thinkers' behind the likes of Bitcoin (Satoshi Nakamoto), currently cryptocurrencies are treated less like currencies and more like property, which leaves them open to follow-up legislation, more specifically, Capital Gains Tax.
So What Is Capital Gains Tax?
As the name partially suggests, if you buy something at an initially cheap value, to then sell it off at a higher price, you pay capital gains tax against the profit you made. Individuals are expected to reflect this on their tax returns, a system that the government wants to have happen for the world of cryptocurrency.
Sounds good to the government, but for the individual traders, depending on the sheer volume they acquire, adding capital gains tax to Cryptocurrency is like adding water to oil, they simply cannot mix. Add trading volume and the volatility of the market and the challenges and finding out the true gain on the selling of their crypto becomes a nightmare.
How Do You Go About Calculating It?
One simple mathematical concept sets the foundation of how to approach capital gains tax, especially within the cryptocurrency world:
Fair Market Value – Cost Basis = Capital Gains Tax
What Is Your Cost Basis?
This roughly translates to how much you initially paid for the asset you currently or used to own. This factor also includes that additional costs incurred when buying the crypto of choice. These include transaction fees or broker commissions, depending of course on how you bought it.
To fully uncover the cost basis, try the following:
(Purchase Price of Crypto + Other Fees) / Quantity of Holding = Cost Basis
What Is The Fair Market Value At The Time Of Selling?
This is the second component you need to fully disclose your Capital Gains Tax amount. The Fair Market Value refers to the cost of the asset at the time you sold it.
For example, if you bought 0.025 Bitcoin at the cost of roughly $50, incurring a transaction fee of $1.49. As a result, the total initial cost basis would be $51.49. Once the bullish run hits in November, you decide to sell your 0.025 Bitcoin at, for example, $400.
From here, you'd split the difference from when you bought it vs. when you sold it, so:
$400 – $51.49 = Capital Gain of $348.51
Here's Where It Gets Problematic – Coin To Coin Trades
Now, that problem on its own is relatively straightforward, not taking into consideration any market fluctuations that were to happen. But where it gets particularly difficult for those involved is when coin to coin transactions come into play.
This is the factor that Coin traders will agonize over, and its something that the IRS doesn't consider when they think of the differences between Crypto and the conventional market.
According to the IRS, each Coin-to-Coin trade is, technically, a taxable event, meaning that when you trade a bitcoin for another crypto, you incur either a capital gain or loss depending on their respective values and what's incurred in committing to the transaction.
Hypothetically, if you bought $100 worth of Bitcoin, and wanted to exchange that with another crypto, So how on earth would you calculate this? You'd first need to find out the Fair Market Value of Bitcoin.
For example, if it was world $160 at the time of trading, so when the transaction takes place, there's a capital gain of $60, which is the taxable element.
Where The Problems Creep In
Now, where it gets to be problematic is when you realize that the government doesn't fully comprehend how crypto traders conduct their business of daily trading. For a significant number, it's a matter of fact that their needs to be a certain degree of automation in measuring market fluctuations and trading.
A large segment of the coin trading population uses some level of automation. Why does this prove a serious problem regarding Capital Gains Tax? Because, thanks to these robo-traders, the experienced coin trader doesn't complete one or two actions, they complete thousands.
This means that measuring the full extent of capital gains is not only agonizing, but it's also simply mathematically impossible on a macrocosmic scale such as we see from automated trading.
So this is a problem without a solution? Well, no, companies are seeing the issues pile up for traders, and have been working to develop systems which allow for useful retroactive measurement of any transactions completed.
How On Earth Do You Report Capital Gains Tax?
To report Capital Gain Tax, you'd need to get a specific form from the IRS, this is Form 8949, which will allow you to detail every crypto transaction that you were involved in from value, dates bought and sold, etc.
You would then need to collate all of the financial information such as total gains on your 1040 Schedule D.
What The Future Holds For Crypto Traders
No-one with half a mind thinks that cryptocurrency is a passing trend, it's not going anywhere anytime soon. The problem is that the questions of what it is, what it should be defined as and how it should be approached by the government regarding taxation will not be going away either.
As a crypto trader, the best thing to do is to keep up to date with how taxes do change and adapt around cryptocurrencies in the future, to prevent any future heartache and headaches when having to approach the next tax year.