When it comes to taxes, fees are one of the things that investors are allowed to deduct from the final sale price of an asset. However, fees come in various forms in the world of Bitcoin. In this article we will take a closer look at how they are handled when it comes to taxes.
Fees are plenty - but not all are equal
Cryptocurrencies give rise to some challenging fee scenarios. You might be paying trading fees in another cryptocurrency, for ex. on a BTC/ETH ticker you will usually pay a fee in BTC. It is also becoming commonplace to pay fees in an exchange's own currency for ex. Binance allows users to pay with BNB while Kraken has Kraken Fee (KFEE). Then there's transfer fees that are paid when you transfer funds between two wallets.
Trading fees are fully deductible!
When you buy, sell or exchange crypto, any fees associated with the transaction should be deducted from the sale price.
Let's look at an example, John buys 1 BTC for $1000 and pays an additional fee of $10. He later exchanges it for 10 ETH. Market price of 1 ETH is $200 at the time of this trade.
The $10 fee is clearly a cost of acquiring the BTC and should be deducted from the sale price when the BTC is eventually sold. The price of the resulting ETH in this case is: 10 x 200 = 2000. So, the capital gain for John is 2000 - 1010 = $990. Even though John hasn't actually sold the crypto, he will need to pay a tax on the $990 capital gain. For an overview of how crypto taxes, check out our tax guide.
Transfer fees not as straightforward
Transfer fees are different from trading fees and may also be subject to different tax conditions. Let's look at a different scenario:
Hillary buys 10 BTC for $10,000 on Coinbase and later transfers these BTC to her Binance wallet, she pays a fee of 0.01 BTC in the process so only receives 9.99 BTC on Binance. Finally, she sells the 9.99 BTC for $20,000.
There are a few ways of handling the transfer fee here.
Method 1: No realized gains
The simplest way is to just reduce Hillary's holdings by 0.01 and keep the value the same. This would mean that the remaining 9.99 BTC are still worth $10,000, so when she sells the 9.99 BTC her gains are $10,000. The 0.01 BTC simply vanishes from her account and no taxable gains are realized on the transfer.
Method 2: Gains realized same way as payment for goods
The second way is to treat the 0.01 BTC fee as a Payment or Withdrawal and realize gains accordingly. Let's say the value of BTC at the time of the transfer has increased to $2000 per BTC, the 0.01 BTC is then worth $20. Since the original price of the BTC was 0.01 x 1000 = $10, Hillary will realize a profit of $10 which will be visible in her tax report. The value of the remaining holdings will be decreased by $10 to $9,990. SO, her final gains will be $10,010, as seen in the screenshot below.
Method 3: Gains realized same way as trading fees
There is a third way of handling this too which is similar to how trading fees work, we could realize a gain and then reinvest that gain into the remaining holdings so value of holdings after transfer becomes $10,010.
What's the right way?
Generally, option 1 is preferred however some tax accountants believe that transfer fees are not strictly related to the acquisition cost of an asset and shouldn't be deducted from the final sale price. In such cases you can switch to option 2 by enabling 'Treat transfer fees as disposals?' in the settings on Koinly:
Don't procrastinate, automate!
If you need help with your cryptocurrency tax calculations, give Koinly a try. It handles fees and other calculations for you automatically. All you have to do is connect your exchange API keys and wallet addresses.