How is Cryptocurrency Taxed? Explained with Examples

Cryptocurrency is gaining popularity and luring newer investors its way every day. While the volatility of the cryptocurrency is a great way to make some quick cash, the taxation is often seen as grey area. While most don’t report crypto earnings, few skip tax liability of crypto altogether just because there isn’t enough information or clarity about it. So, here we are to clarify everything about Cryptocurrency and taxes. 

Is crypto taxable?

Yes, crypto is taxable and needs to be taxed as a capital asset.

Cryptocurrency, decentralized currency or digital money, however you like to call it, was designed as a token for value exchange that exists strictly digitally. There is no centralized organization managing it, hence the ‘decentralized’ identity. The transactions are validated and the ownership are recorded in ledgers that are stored in every node of the blockchain making it very secure and robust. While cryptocurrency has its advantages, there are limitations too. 

Though it has been more than a decade of existence for bitcoin, the first ever crypto, the financial system and governments are not completely ready for the adoption yet. The laws governing crypto are in the making as more and more people understand and believe in its potential.

Only around the 2014-15 most countries started to recognize crypto and passed regulations to be taxed as an asset. The crypto company formation and the intricacies of crypto are still are left to be explored. 

How is cryptocurrency taxed?

Cryptocurrency is taxed as a Capital asset in countries which recognize and allow crypto trading. By capital asset, crypto is treated similar to share, bond or a property and subjected to capital gain taxes on the profits made. 

If you know how taxes are calculated on shares you already know half of crypto taxation. The similarity starts with being able to buy both on exchanges and increase in value of token/share which is the most common form of profit. While some cryptocurrency can be used to procure goods, shares cannot be used to buy products.

Though cryptocurrency is developed to replace regular currency, right now it acts as a medium of wealth storage that has a potential to grow or diminish in value based on demand and supply. Hence the capital asset class for cryptocurrency. 

The default capital gains tax rates apply to your crypto transactions in accordance with the income slab both of which are specific to the country you live in. Apart from the residing country there are more factors on how the tax is calculated. 

For beginners, here is an example of how cryptocurrency is taxed. 

You buy a bitcoin for $100 and you sell it later for $150 which gives you a profit of $50 which is subjected to capital gain taxes under the norms of the country you reside in. 

Factors affecting crypto tax calculation

Nature of use –

Acquiring- Mining, buying from the exchange, buying from the crypto makers, exchange for a product.

Releasing- selling on the exchange, exchanging for product, exchange for another crypto currency

Period of owning –

Short-term (or) Long-term

Acquisition

It is how and from who you acquire crypto token.

Cryptocurrency can be acquired from mining – an activity that uses computer hardware resources to serve as a node of the blockchain that credits crypto tokens in exchange. You can also purchase from a crypto exchange or directly from the crypto creators (like IPO for shares) or in exchange for products in a marketplace. Everything other than mining comes under the same category – Buying. 

Releasing 

The most common way of crypto release is selling it on an exchange. With advancements in crypto adoption in mainstream, some vendors and payment providers facilitate use of cryptocurrency as an alternative fiat currency to buy products. Here the equivalent of fiat currency, say USD is paid in Bitcoins or Ether. The other way of release is swapping a different cryptocurrency for one. 

Owning period

The period of ownership of crypto currencies determines the nature of investment – either short or long term. It is necessary to know the duration because capital gain taxes apply differently to short- and long-term capital assets. 

In the US one year or lesser counts as short-term whereas in India short-term capital investment refers to 3 years. So, know the difference between short- and long-term investment based on your residential laws. 

Taxes on Crypto currency 

Crypto transactions can be taxed under three categories – Your personal income tax, business tax or capital gains tax.

Cryptocurrency transactions subjected to capital gains taxes

  • Selling long term crypto holdings for fiat money
  • Trading/swapping long term crypto holdings
  • Paying for product/service with cryptocurrency (through Crypto debit cards)

These transactions are considered appreciated/depreciated capital assets. Hence, the taxes are calculated based on the difference of sold price to buying cost. 

Example: If a bitcoin is bought 3 years ago for $40,000 was sold for $50,000 and the capital gains tax level for your income level is 20% then your tax is, 

(50,000-40,000) * 20/100 = $200

Cryptocurrency transaction taxable under the personal income tax

  • Hobbyist crypto mining, 
  • Short-term crypto investment (trading),
  • Crypto paid as a salary, 
  • Airdropped cryptocurrency received from hard fork. 

Transactions where cryptocurrency is offered/earned as compensation for work/product/service is considered as income. The value taxable from these transactions is the cryptocurrency equivalent of fiat money of the country during the time of payment. 

Example: if you have received 2 bitcoins as compensation for work on June 1st, then the average value of the day (say, $40,000) should be taken into account for the crypto tax filings. The income tax rate for your income slab is 12%, then

(2*40,000) * 12% = $9,600

Cryptocurrency transaction taxed as a business income

  • Mining as a business 
  • Crypto acquired in sale of a product/service

Income generated for a business, paid through cryptocurrency will be taxed as business income. The business taxes vary widely with type of business formation and ownership. 

Non-taxable cryptocurrency transactions

  • Buying cryptocurrency using fiat money
  • Gifting
  • Donating (offers tax credit)

Gifting and donating up to permissible limits on cryptocurrency are either tax free or gives tax credit. 

Are There Taxes on Bitcoins? (investopedia.com)

How Is Cryptocurrency Taxed? – Forbes Advisor

The Crypto Tax Nightmare Facing New Traders (forbes.com)

Visa, MasterCard crypto credit and debit cards: Should you get one? (cnbc.co

Income Tax on Cryptocurrency Gains: What Do the Rules Say? | NDTV Gadgets 360m)

How Is Cryptocurrency Tax

9 Ways to Cut Crypto Taxes Down to the Bone | Kiplinger

ed? Here’s What You Need to Know | Kiplinger

How Is Cryptocurrency Treated For Income Tax Purposes? (ndtv.com)

How income tax rule applies on your cryptocurrency gains — Explained (livemint.com)

UK Cryptocurrency Tax Guide | CoinTracker