In the past few months, the buzzwords have been “cryptocurrency, DeFi and NFTs.” This is due to the popularity of how individuals are leveraging cryptocurrency to create wealth and make it a source of income. The major advantage is the leverage of blockchain and how decentralization allows financial inclusion regardless of race, age, color, and location.
All of these financial benefits are ascribed to the volatility of cryptocurrencies. It is the same with how we witnessed Bitcoin (BTC) reaching different all-time highs like $60,000. Likewise, Ethereum (ETH) increased its price four times early this year.
However, other cryptocurrencies—such as Litecoin, Shiba Inu, Dogecoin — create enormous waves in the crypto space. These virtual currencies make it possible for investors to double their income in short times due to the market hype and different use cases attached to them.
As much as there are a lot of financial benefits attached to crypto as a mainstream word, there is a part of crypto investment most people are not discussing. Its importance cannot be ignored, but a boring topic can discourage you from getting involved. It is the topic of cryptocurrency taxation.
Most individuals do not engage in the discourse of crypto tax implications. And this is due to a perception that it is a boring subject. But the truth is, crypto traders cannot ignore it for long because it will still cut across non-fungible tokens (NFTs) in no time. Thus, we must understand how we can file taxes for cryptocurrencies.
The Concept of Crypto Taxation
Meanwhile, the concept of crypto tax is based on evaluating cryptocurrency as property. As a result, crypto taxation undergoes the same evaluation property tax will undergo. This explains that you will pay tax for selling your crypto, trading it for another crypto investment, or making a crypto purchase. This same rule applies to taxing NFTs.
The below illustration is written for better comprehension of the crypto tax concept.
Assume you purchased 1 BTC for $25,000 on 30th March 2020, and you sold it for $35,000 on 4th August 2020. That explains you’ve made a gain of $15,000. And this $15,000 is taxable as gains in the short term. But crypto tax is very tricky for individuals that frequent traders. These trades arise as a result of different reasons.
For instance, you have $35,000 worth of BTC and need to make an NFT purchase. First, it is important to have Ethereum in your wallet before buying the NFT. Since you need ETH to purchase NFT, you will trade BTC for ETH. You face tax implications on your $15,000 gains despite this crypto exchange because crypto is regarded as property, and the exchange qualifies for taxation.
Another scenario that might play out is you trying to use the gains from your crypto investment to make a purchase. An instance is having your crypto investment of BTC growing to $40,000 from $4,000. Then, you use the $35,000 gains to purchase a new car. That means that you have $35,000 income that is taxable. And you must record this in your tax documentation.
You might think it is a simple coin swap. But the truth appears like buying a stock at a lower price and selling it off when the price skyrockets.
Short-Term vs. Long-Term Taxation Concepts
One more important thing you can’t take away from crypto traders is the consistent transactions in a number. Due to the constant movement of “buying the dip and selling when it spikes” in the crypto space, the number of transactions in a day sum to a large. And this system undergoes a repeat session in the space.
However, it may be difficult for new crypto traders to understand crypto taxation for gains obtained from crypto trades. One way to know is to pay long-term capital gains tax when you hold a crypto investment for a year. And capital gain tax is lower compared to ordinary income tax rates. But the profits are classified as short-term capital gains when held for less than 12 months.
The purpose of this large difference in the tax system is to encourage crypto investors to participate in long-term investment purposes. That is why day traders can incur large tax billings on their profits than those holding for a long time.
If you believe that crypto tax is not real and impossible, it is time you think again. Cryptocurrency is the taxable and individual nation is working towards establishing tax rules that will make it easy to tax cryptocurrency. Some have it in place already, while some are working on it. There is no responsible citizen that would want to evade tax.
As a crypto trader, understand that it is impossible to avoid tax. You can’t. And the unpleasant part is you have to pay interest on your unpaid taxes. This makes the tax agency aggressive and descends on you for tax consequences. It’s important to ensure that the tax agency gets its crypto tax without a need for a business clampdown.
However, the best option is to reach out to a tax professional if you are unsure, you can come up with a crypto tax bill by yourself.