Everybody thinks of how much money they are going to make when they buy bitcoin or other cryptocurrencies. They can already picture the Lambo in their garage! Yet, nobody really puts much thought into how their newfound wealth is going to affect their tax situation.
Your tax situation and what you need to pay are going to depend on a lot of different factors. There is where you live that mostly comes into play as different countries have their own tax codes to deal with this new way of making money. For instance, if you buy Ethereum Canada will have a much different tax structure than a country like Switzerland.
The problem is also that bitcoin is not like an ordinary currency and it sits in some strange gray areas. This confuses governments that need to make sure that they are able to get some tax revenue without stifling the use of said currency. Since bitcoin can easily fly under the radar there is even more of an incentive to make sure that it is taxed correctly.
In this article, we will go over how you can likely expect your gains from cryptocurrency to end up taxed.
What is cryptocurrency?
Cryptocurrency is not a currency at all, in reality. Though it does hold value as people have decided that it is worth something.
Cryptocurrency is built on a technology called blockchain that is simply a ledger. This ledger records transactions that are encrypted so they can’t be changed. And the reward for the person who solves the encryption so the transaction can be sealed is rewarded by getting a small amount of the token of that particular blockchain.
The system is completely decentralized as there is no bank or central authority in charge. The whole system relies on the consensus of the people doing the encryption. As such, there is no need for trust at any point of the process since all of the transactions are transparent and visible to anybody who has a copy of the blockchain on their computer.
This makes it a very powerful currency since it can be used to pay for just about anything these days and anyplace in the world.
Selling goods and services
From the previous section, you probably gathered how confusing it is since there is no real currency created here. However, there is a value given to it since you can accept it as a form of payment. This brings us to the first way that bitcoin can be taxed.
If you are an individual or company you can accept bitcoin as payment for any goods or services that you sell. In this case, bitcoin is just like any other currency. However, since it isn’t a currency, the government accepts this transaction as a barter. You are offering your goods and services in exchange for something that you have both agreed on as far as value but it is not a currency. It would be like selling a crate of oranges for some bacon.
The thing is that usually, these are taxable goods. And there is usually a Canadian dollar amount that is fixed on these goods and services. So, you have to then calculate what these goods would be worth in legal tender and count the amount of bitcoin as if it were worth at least that amount. This is a fair market value.
Rather than report how much bitcoin you received for your work, you will report how much the work or goods were worth. If you offer your services for $20 per hour, for example, then whatever amount of cryptocurrency you received in exchange will be worth the same amount. This is how much you will report for revenue for those payments.
As a commodity
Commodities are things that are bought and sold for profit. So, if I buy an ounce of gold and then sell it later to somebody else for more money then gold is a commodity in this case.
It is exactly the same as when you buy and sell your cryptocurrency. The profit you make from the sale will be taxable. Unfortunately, there is some gray area as to how much you will pay if this is the case. Is it income or is it capital gains?
It does depend on how the bitcoin is used and who is buying it and for what purpose when it comes to the type of tax umbrella it falls under.
Mining and staking
The process of encrypting and verifying the blocks on a blockchain is called mining since the reward is a share of the cryptocurrency. Many people earn their bitcoin in this way as they have a network of computers that does the computing for them.
This is an even grayer area as far as taxes go because it depends on why you are mining. Some people might mine because they believe in the concept of the blockchain and treat it like a hobby. The income is just a bonus for them. On the other hand, if you are trying to make a living with that money then it is considered a business, and the tax structure changes.
Staking is just a little bit different than mining for cryptocurrency as it involves a person being chosen to validate a block. The result is a reward of cryptocurrency so the tax implications are identical to mining.
Buying cryptocurrency with cryptocurrency
This is the most straightforward of the tax structures for cryptocurrency. Since there is an actual dollar value of cryptocurrency, when you use one to buy another you can see the actual value of the transaction. So, if your acquisition makes you more money than when you bought it the difference is considered a capital gain.
It’s easy enough to figure out since the capital gains rate is 50%. If you lose money then it comes under a capital gains loss and can be deducted from your income from other sources.
This article has been contributed on behalf of Paxful. However, the information provided herein is not and is not intended to be, investment, financial, or other advice.