Getting a fiat (e.g. USD) loan against your appreciated cryptocurrency is a great way to get liquidity on your cryptocurrency without paying capital gains taxes. Platforms like BlockFi, Celsius, Nexo, Crypto.com, and others allow you to take loans against your crypto assets. This post will break down the tax implications of these loans.
Receiving a bitcoin loan
Receiving cash for depositing your cryptocurrency as collateral is not a taxable event. This is similar to getting a home equity line of credit where you collateralize your home with the bank and get cash against equity.
Let’s say David purchased 1 bitcoin (BTC) in 2017 for $1,000. It is now worth $50,000. David decides to deposit his BTC as collateral in BlockFi and get a USD loan. BlockFi offers him a $30,000 loan. This $30,000 is not taxable to David and he doesn’t have to report this amount in any tax forms.
Spending the loan proceeds
Spending the cash received from a crypto-backed loan is not taxable either. You can spend the cash proceeds without incurring taxes, however, failure to repay the loan could lead to a taxable event.
Interest expense on cryptocurrency loans
Cryptocurrency lending platforms charge an annual interest rate for lending cash against cryptocurrency. This rate fluctuates but is generally in the ballpark of 5%. You can write-off the interest expense on your taxes if you use the loan proceeds for either investment or business purposes.
Investment purposes include investing the loan proceeds to purchase other cryptocurrencies or investing in traditional assets like stocks and securities. If you are using your loan for investment purposes, you can deduct your crypto loan interest expenses on IRS Form 4952.
A business purpose would be a situation where you invest the loan proceeds in a rental property or an ongoing business with the intention of making a profit. In this case, your crypto loan interest expense is deductible on the business tax return.
Note that if you are using the crypto loan proceeds to cover personal expenses such as groceries, furniture, or a new Lamborghini, interest expense is not deductible.
Paying off the bitcoin loan
Generally speaking, paying back a loan and unlocking your cryptocurrency collateral is not a taxable event. Continuing with the example above, say David paid back $30,000 to BlockFi and received back the 1 BTC he deposited. This is not a taxable event for David even if the price of BTC has gone up in value while it was locked as collateral.
When handled correctly, cryptocurrency loans do not result in any taxes. That said, the IRS could technically argue that cryptocurrency loans are taxable because cryptocurrencies like bitcoin may not be considered completely fungible like fiat. However, the chances of crypto-backed loans being treated this way are remote.
When do you have to pay taxes on bitcoin loans?
There are a few situations where bitcoin loans generate a tax obligation.
First, if a loan is not paid back, the lending platform can liquidate your collateral to cover their losses. This liquidation event can create a realized capital gain (or loss) event for you.
Say David bought a boat with his loan and decided not to pay back the $30,000 loan. On this day, BTC is trading at $31,000. In this case, the lending platform can liquidate his 1 BTC subjecting David to a $30,000 ($31,000 - $1,000) capital gains. Thus, defaulting on a cryptocurrency-backed loan is not a path to cash out without paying capital gains taxes.
Second, price volatility can also lead to liquidation. For example, if the price of the collateralized bitcoin falls below a certain threshold set by the lending platform, they reserve the right to liquidate the collateral to protect themselves from losses. To avoid liquidation and the resulting taxes, users need to either supply additional collateral or pay off the loan.
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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.