The truth remains that most people barely know anything about either of these topics. Moreover, the two subjects represent two vast opposites terms from a cultural perspective. And in the eyes of many persons, tax law represents excessive regulations laid down by the central government agency, which are imposed on its subjects. This is in itself is a contrast to cryptocurrencies and the associated blockchain technologies which stand for a decentralized, unregulated and free society not under the control of a central power apparatus. More exacerbating is the reality that the complexity of these two spheres increases.
Where is it taxed?
The taxation of cryptocurrency varies from place to place. For example, in the United States, cryptocurrency is treated like real estate instead of being treated as a currency – it is treated as a property. It is also treated as a commodity like gold in some cases, and therefore it is subject to both the short-term and long-term capital gains tax. In most cases, it is regardless of whether it is used for the purchase of goods/services or for trading/investment.
On the other hand, countries in Europe follow a decentralized approach to the regulation of cryptocurrency. The United Kingdom treats Bitcoin like a foreign Currency. In Germany, if Bitcoin investments are held for less than one-year, German income taxes will apply. In Germany, income taxes are progressive and can be up to 45%. Even in Switzerland, cryptocurrency taxes are levied. This implies that Swiss residents will have to pay income tax, profit tax, and wealth tax on their cryptocurrency holdings.
However though, in just about all European countries as well as in Liechtenstein and Switzerland, the sales of cryptocurrencies are exempt from the Value Added Taxes.
A special feature in Liechtenstein is the integration of tax on wealth into income tax, as well as the principle that a source of income is either subjected to wealth tax, or to income tax. This helps to prevent double taxation. This means that every natural person with unlimited tax liability will have to declare holdings of cryptocurrencies at the beginning of every fiscal year and convert the values to their Swiss franc equivalent. More so, speculative gains from trading in cryptocurrencies are tax-free and do not necessarily have to be declared. This is not only very attractive in terms of the tax burden, but provides significant administrative relief as well.
As seen from the official IRS guidance, 2014; we understand that:
- Trading cryptocurrency to cryptocurrency is a taxable event
- Trading cryptocurrency to fiat currency like the dollar is a taxable event
- Using cryptocurrency for goods and services purchase is a taxable event
- Gifting cryptocurrency is not a taxable event the recipient will inherit the cost basis. The gift tax still applies if you exceed the gift tax exemption amount.
- A cryptocurrency wallet-to-wallet transfer is not a taxable event as you can transfer between wallets or exchanges without realizing capital gains and looses, so make sure to check your records against the records of your exchanges as they may count transfers as taxable events as a safe harbor),
- Also buying cryptocurrency with USD is not a taxable event. As you don’t realize gains until you trade, well or make use of your crypto. If you hodl longer than a year you can realize long-term capital gains they are about half the rate of short-term capital gains if you hold less than a year you realize short-term capital gains and losses.
It is therefore established that anything other than buying, holding, or transferring a cryptocurrency is a taxable event and this means you realize capital gains and losses at fair market value at the time of the event when you trade, sell, or use crypto.
How to pay
You’ll need to be prepared to pay capital gains taxes thus you will need fiat currency at tax time.
For the average Bitcoin user;
- If you trade cryptocurrency for a good or service, it is important that you keep record of the transactions and report a fair-market value of the currency at the time of the transaction.
- For times cryptocurrency is traded as a capital asset, either for another cryptocurrency or fiat currency (like the US dollar), you would need to keep a record and report all those transactions by using the fair-market values of cryptocurrencies in situations where one cryptocurrency is traded for another. Also, at the end of the year, you would need to report all cryptocurrency transactions and all the related gains and losses. You would then pay taxes accordingly (based on your total gains).