Want to understand cryptocurrency tax? The theory behind crypto tax is not as cryptic as you might think. That's because most countries use familiar tax law on cryptocurrencies like Bitcoin. Follow our short guide for Accountants and learn how.
Crypto is an asset
Instead of thinking of crypto as a currency, a more accurate label would be crypto-asset, as ‘asset’ is the magic key that unlocks the crypto tax riddle.
An asset is any resource that you own, with economic value that's expected to provide a future return, like shares, investment property, and collectibles - and cryptocurrency is lumped in the very same basket. Therefore, think of crypto as property and an asset for tax purposes.
Capital gains tax
Just as shares and investment property disposals attract Capital Gains Tax, so too does cryptocurrency.
So when it comes to calculating the tax owed on crypto gains, all of the usual considerations apply - you'll need to know the cost base of the crypto 'asset', the price of the crypto at acquisition and disposal, and convert all figures into your client's local currency. Depending on your country's tax rules, a crypto capital gain, or capital loss, could be triggered by 4 disposals:
- Selling crypto like Bitcoin, into any fiat currency, like USD.
- Swapping crypto for crypto, like Bitcoin to Ether.
- Using crypto to buy goods or services
- And, giving crypto as a gift
Capital gains tax-free threshold
In countries where a capital-gains tax free threshold applies, crypto gains should get the same treatment.
Capital gains discount
In countries where a capital gains discount applies for holding, crypto is usually afforded the same discount on disposal.
- USA - the IRS applies a lower capital gains tax to long-term investments versus short-term investments
- Australia - hold for a year and pay 50% less capital gains
- Germany - hold for a year and pay 100% less capital gains
Just as income can originate from work or investments and be taxed under Income Tax, so too can crypto income. In terms of cryptocurrency, the parallels look roughly like this:
- Getting paid in crypto - like a salary
- Staking rewards - like dividends
- Mining tokens - like income
- Airdrops - like bonuses
- DeFi interest - like bank account interest
- Referral bonus - like commission
Buying is tax free
Under most tax laws, the purchase of an asset for investment is tax free, bar any applicable goods and services tax / value added tax. Typically, your crypto investor clients won't pay tax on their cryptocurrency purchases.
Likewise if you are the recipient of gifted crypto, there is no tax to pay.
In each of these cases, while crypto might be tax-free on the way in, your client's will very likely pay capital gains tax on the way out.
Clients could pay both income and capital gains tax
How crypto is received, and disposed of, are seen as two separate events. Let’s imagine your client receives crypto via an airdrop on Jan 1, and that the coins are worth $50. This $50 is income, and will form part of their total taxable income. Come June 1, they decide to convert their airdropped coins into dollars.
Those same coins are now worth $80. As they paid no fees in receiving the airdropped coins, the gain is a straightforward calculation of $80-$50 = $30. In disposal they need to pay Capital Gains Tax on that $30, even though they're paying income tax on the original $50.
As you know, a cost basis is the amount you spend to acquire an asset, including the purchase price, transaction fees, brokerage commissions, and any other relevant cost. As an asset, crypto gets handled in the same way. To calculate crypto cost basis, we simple take the Purchase Price plus Fees divided by Quantity. The cost basis also depends on the accounting method used:
Calculating crypto taxes with ACB - Average Cost Basis method
The Average Cost Basis (ACB) is the simplest of all accounting methods. The Average Cost Basis is calculated as the total amount paid to purchase the cryptocurrency divided by the total number of cryptocurrency held.
ACB is widely used in Canada and Sweden. In the US however, the Internal Revenue Service (IRS) does not allow investors to use CB to arrive at the cost of their holdings, crypto or otherwise.
Calculating crypto taxes with FIFO - First in First Out method
Crypto cost basis is calculated on the assumption that the first crypto sold is the first crypto bought. Widely used, benefits long-term holdings & a bull market. FIFO if prefered in Australia, UK and USA.
Calculating Crypto Taxes with LIFO (Last in First Out)
Crypto cost basis is calculated on the assumption that the first crypto sold is the last crypto bought. Results in lower taxable profits, better suited to crypto businesses.
Calculating Crypto Taxes with HIFO (Highest in First Out)
The cost basis for a sale is the cost basis of the most expensive crypto that you acquired. This means that crypto assets that have the highest cost basis are the ones that are first sold. As capital gains are equal to total proceeds less the cost basis, a larger cost basis means your client's capital gains are minimized.
Cryptocurrency tax is a lot easier to understand once the connection to capital gains and income tax is made.
Unfortunately, that's where the simplicity ends. Just like with regular assets and income, taxpayers need to keep records on dates and details. Except when it comes to crypto, you're also throwing currency conversions into the mix, along with historic spot prices for the crypto stock at date of acquisition and date of disposal.
Whereas a spreadsheet might do the trick for tracking regular shares, most tax offices recommend using a third-party software to help meet the record-keeping obligations and working out your client's crypto tax.
Koinly's Accountant Platform is just that, a crypto tax calculator that imports all your clients' crypto trade data to figure out their taxable totals - in line with the requirements of the IRS, HMRC, ATO and other tax offices.