In the past few years, use of cryptocurrencies for investment, trading, and as a means of payment is steadily rising. That being said, one important factor to consider is cryptocurrency taxes.
Digital nomads, around the world are already beginning to allow payments in Bitcoins and other cryptos in their location independent businesses.
Recent success stories in crypto trading have gained a lot of attention from traditional investors who so far, had only invested in equity markets and had negative views about cryptocurrencies.
However, crypto has also generated a lot of concerns for both governments and investors.
In this blog, we’ll provide an easy yet detailed explanation on when and how taxes apply on crypto trades; and how to calculate and pay them.
Table of Contents
- Cryptocurrency Taxes – Overview
- Taxes on Cryptocurrency Events
- Type of Taxes on Cryptocurrency
- Crypto Tax Rates
- Valuation Methods For a High Number of Transactions
- Crypto Tax Friendly Countries
- Conclusion – Cryptocurrency and Taxes
Cryptocurrency Taxes – Overview
One of the prime discussions around the world is how to possibly tax cryptocurrencies.
In some instances, it seemed paradoxical that certain governments didn’t want anything to do with cryptos but then decided to put a tax anyway on crypto gains made for investors and traders.
Here are some frequent questions I receive from traders and investors.
How Much Cryptocurrency Tax Apply for Investors?
The tax rate on cryptocurrency for investors typically depends on the tax laws of their country and whether the gains are considered capital gains or income.
In the U.S., for instance, the tax rate can vary from 0% to 37% for short-term capital gains and 0% to 20% for long-term gains, depending on the investor’s income bracket.
Investors are generally taxed on the profit made from selling or trading cryptocurrency, calculated as the difference between the selling price and the acquisition cost.
Are There Any Specific Tax Exemptions or Incentives for Cryptocurrency?
Tax exemptions or incentives for cryptocurrency investments vary by country. Some jurisdictions might offer tax-free thresholds, where small gains are not taxed.
Others might have long-term capital gains tax incentives, which encourage holding cryptocurrency for a certain period.
However, as of now, most countries do not offer specific tax incentives for cryptocurrency compared to other investment types, reflecting the cautious regulatory approach towards digital currencies.
How Are Cryptocurrency Gifts and Donations Taxed?
Cryptocurrency gifts and donations typically follow similar tax rules to those of other assets. In the U.S., if you gift cryptocurrency, you are not liable for taxes unless the gift exceeds the annual exemption limit.
The recipient, however, may be taxed upon selling the cryptocurrency, based on its fair market value at the time of the gift.
Donating to a qualified charity can be tax-deductible, and the donor may not incur capital gains tax on the donated amount.
How Are Losses from Cryptocurrency Investments Treated for Tax Purposes?
Losses from cryptocurrency investments can often be used to offset capital gains from other investments for tax purposes.
If your losses exceed your gains, you can typically deduct the difference from your taxable income, up to an annual limit, with the possibility of carrying forward excess losses to future years.
This treatment can provide a tax advantage by reducing overall taxable income, highlighting the importance of accurate record-keeping for all transactions.
What Are the Most Tax-Friendly Countries for Crypto?
Some countries are more favorable for cryptocurrency taxation, attracting investors with their tax-friendly policies.
Portugal, for instance, stands out as one of the most crypto-friendly countries, not taxing gains from the sale of cryptocurrencies for individuals (as of my last update).
Similarly, Germany offers tax exemption on crypto gains if the assets are held for more than a year.
Singapore and Malaysia also have favorable tax regimes, where individuals are not taxed on long-term capital gains from cryptocurrency. However, it’s crucial to note that regulations can change rapidly, and professional advice is recommended to stay updated on the latest tax laws.
For a more detailed explanation, we highly recommend you check out the Crypto Tax Tips Masterclass.
Taxes on Cryptocurrency Events
A taxable event means when tax becomes applicable on your crypto transactions. In the majority of countries, cryptocurrencies are treated as a commodity or asset and not currency for the purpose of taxation.
Thus, gains realised on the sale of cryptocurrencies is treated as income for the purpose of taxation.
This income can be ordinary business income if you are considered to be a trader, or long-term capital gain or short-term capital gain based on the holding time and treatment of cryptocurrency.
Every tax has a taxable event at which point tax is attracted on the transaction. Generally, such a tax event arises at the time when you receive the right to earn any income.
In the case of cryptocurrencies, the taxable event arises in the event of:
- Selling cryptocurrency in exchange for fiat currency such as $ or £.
- Trading a cryptocurrency to a different coin [for example – exchanging Bitcoin with Ethereum.]
- Using cryptocurrency as a payment for goods or services. [Using Bitcoin to buy a car.]
- Earning cryptocurrency in course of business or job.
- Mining cryptocurrencies
- Staking, airdrops yielding, and farming cryptocurrencies
Further ahead, we will learn how to calculate the amount on which tax rate will be applied for each of the above scenarios.
Type of Taxes on Cryptocurrency
Cryptocurrencies, when invested or traded other than in the ordinary course of business i.e. investment done as a hobby or side hustle, which is in 90% cases, attract short term capital gain or long term capital gain tax.
In most scenarios, if the holding period of the cryptocurrency i.e. the time period between purchase and sale of the crypto, is a short time frame .
For example, less than 12 months then the short term capital gain tax applicable can be significantly higher than if the holding period is for a longer-term ie. Longer than 12 months.
For example in the case of the USA, the tax brackets of short-term capital gain are similar to ordinary income tax brackets.
While the long-term capital gain tax brackets are much less than the above two. Thus from a tax perspective, it is more beneficial to hold cryptocurrencies for a longer period of time.
Crypto Tax Rates
The exact rate of tax applicable for different persons will depend on your total income from all sources of income such as profits from other businesses, wages, rental income, etc.
For example in the US, if the total income from all sources of income including gains from the sale of crypto is $100,0000, then for a single individual the rate of tax will be 24% in case of short-term capital gain.
But if the holding period was more than 12 months, then the long-term capital gain rate would drop down to 15%.
In the case where you are in the business of trading in cryptocurrencies on a regular basis, the income earned from such trading is considered to be ordinary income and treated as such. The rate of tax applicable in such a case will depend on the total income of the person depending on what their personal marginal tax rate is.
Calculation of Gain or Loss
In order to compute the amount of gain or loss made from the sales of cryptocurrencies, the difference of selling price less cost of sales and purchase price including associated costs must be calculated. The formula will look something like this:
Gain/Loss = [(Selling price – costs of sales) – (Cost Price + Associated costs of purchase)]
Tip: don’t forget the fees associated with acquiring your cryptos as these can be included in the cost price and a lot of people forget to include them.
It gets a little bit more complicated…
The above calculation is a very simple way of figuring out your crypto taxes and if you’re a hodler (someone who holds their investments long term) then you won’t be faced with too many difficulties in figuring out how much crypto taxes you owe.
However, if the transaction is of a nature other than direct selling i.e. trading a cryptocurrency to a different cryptocurrency, using cryptocurrency as a payment for goods or services, or earning cryptocurrency in course of business or job, then the selling price of cryptocurrency cannot be ascertained directly.
In such cases, in place of the selling price, fair market value will be used.
Hence the above formula is no longer valid:
Gain/Loss = [(Fair market value – costs of sales) – (Cost Price + Associated costs of purchase)]
In every case, fair market value will be calculated differently as explained below:
1. Trading a Cryptocurrency to a Different Cryptocurrency
Suppose, you exchanged 1 Bitcoin for 10 Dogecoin and the value of 1 Dogecoin was $10. Then the fair market value of Bitcoin given will be 10 * $10 = $100.
2. Using Cryptocurrency as a Payment for Goods or Services
Suppose, you paid 1000 Bitcoins for a car worth $50,000. Then the fair market value of each Bitcoin paid will be $50,000/1000 = $50.
3. Earning Cryptocurrency in Course of Business or Job
Suppose, your employer gave you 500 Bitcoins in lieu of your monthly wages of $20,000. Then the fair market value of Bitcoin will be $20,000/500 = $40.
Thus, it is very easy to calculate the gain or loss if the number of transactions are limited as opposed to if you use your cryptocurrencies more regularly.
Valuation Methods For a High Number of Transactions
If you’re doing up to 100 or even thousands of transactions every month, then it will become increasingly difficult to calculate the profits on a case-by-case basis.
In such cases, different costing methods such as the FIFO method, LIFO method, weighted average method have to be applied. Generally in most countries, FIFO or weighted average method is used.
Suppose you purchased 1 Bitcoin each in three instances at the price of $10, $20, and $30 respectively and then later sold 2 of them at a price of $40 each. Then,
In case of the FIFO method, the cost of 2 Bitcoins will be the cost of the first 2 Bitcoins purchased i.e. $10 + $20 = $30. Thus, the gain in this sale will be ($40 + $40) – ($30 as calculated above) = $50.
Weighted Average Method
In case of weighted average method, the cost of each Bitcoin will be the average cost of entire purchase in the period i.e. ($10 + $20 + $30)/3 = $20. Therefore, the total cost of 2 Bitcoins will be $20 * 2 = $40. Thus, the gain in this case will be ($40 + $40) – ($40 as calculated above) = $40.
So, we can see that the method applied to calculate the gain or loss can even change the gains or losses to some extent.
In some countries, where the option is available for taxpayers to select the method, then a detailed calculation should be done before deciding which method to select.
However, once a method is selected, then in ordinary circumstances, it is not allowed to be changed in the subsequent years. Thus, the method beneficial in the current year may not be beneficial next year.
Crypto Tax Friendly Countries
Understanding the ryptocurrency taxation can be complex, as you understood with this guide, but some countries offer more favorable tax environments for investors.
Let’s talk about some countries that are more favorable in terms of cryptocurrency taxes.
In Germany, cryptocurrencies are not treated as currency, stocks, or commodities, which offers a unique tax advantage.
If you hold your crypto investments for more than one year, they are exempt from capital gains tax. This long-term holding policy encourages both investment and stability in the crypto market.
Moreover, Germany doesn’t tax cryptocurrency purchases or usage, provided the holding period exceeds a year. This approach positions Germany as an attractive location for crypto investors seeking to maximize their long-term gains without incurring significant tax liabilities.
Portugal is widely recognized as one of the most tax-friendly countries for cryptocurrency. The country does not tax the gains from the sale or exchange of cryptocurrencies for individuals, as long as they are not professional or business activities.
This policy makes Portugal an appealing destination for individual crypto investors and digital nomads.
Additionally, cryptocurrency trading is not considered investment income, which traditionally attracts high tax rates in many countries.
Portugal’s stance on crypto taxation encourages individual investors to explore and invest in cryptocurrencies without the concern of significant tax burdens.
Singapore stands out in the crypto world for its favorable tax policies. In Singapore, individuals are not taxed on long-term capital gains, which includes gains from cryptocurrency investments.
This means that profits from the sale of digital currencies are not subject to taxation, provided they are not part of a business.
This tax exemption applies to both locals and foreign investors, making Singapore an attractive global hub for cryptocurrency investment.
Malta offers a progressive and friendly regulatory environment for taxes cryptocurrencies.
While it does not provide a blanket tax exemption on crypto gains, Malta’s framework is designed to support and regulate the growing crypto industry effectively.
For individuals, cryptocurrency investments are not subject to capital gains tax unless they are held as trading stock in a business.
Switzerland is renowned for its favorable stance towards cryptocurrencies and blockchain technology.
Individual investors in Switzerland are not taxed on capital gains from the sale of cryptocurrencies, provided these activities are not professional.
Furthermore, Switzerland’s cantonal system means tax rates can vary, offering potentially more favorable conditions in certain regions.
Conclusion – Cryptocurrency and Taxes
In any case, you will have to maintain a detailed record of the purchase and sale of cryptocurrencies with separate entries for every transaction in each type of cryptocurrency with the separate date and rate columns. This is proving to be very difficult for a new crypto and hobby investors.
But now, most crypto trading platforms allow you to generate these data with one mouse-click and you can simply extract the information and provide it to your accountant who will hopefully do the crypto tax calculations of gains or losses from all the different crypto trade on your behalf.
If you’re looking for specific guidance on cryptocurrency taxes in different countries, we have something for you. Our recommended software helps our clients manage their crypto taxes effectively.
For a comprehensive understanding of how to potentially reduce your crypto tax liabilities and simplify your long-term financial management, our resources are invaluable.
Be sure to explore our Crypto Tax Tips Masterclass. It’s especially beneficial for individuals from high-tax Western countries. This masterclass offers detailed strategies and tips to make managing your crypto investments more efficient and potentially more profitable.
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NOTICE: The content of this article is not to be considered as a legal opinion or tax advice. Wanderers Wealth does not hold itself out as a legal or tax advisor. If you want to receive a legal opinion or tax advice on the matter in this article please contact us directly and we will refer you to a legal practitioner.