Last Updated: September 25, 2020
This article was originally published on Forbes by Shehan Chandrasekera on December 28, 2019
In this post (part 3 of 6), we will take a deep dive into what’s covered under the “sell” category of the crypto question on Schedule 1 and outline taxable and non-taxable transactions. Note that almost all cryptocurrency sales are taxable and would require you to check “yes” on crypto question on Schedule 1. For those of you who are still wondering why you have to answer the “crypto question” when you file for taxes, check out why the IRS included it here.
The following transactions would fall under the “sell” category on crypto question. Some are obvious and some are not.
- Selling crypto assets in exchange for USD - Selling cryptcurrencies and receiving USD is probably the most common transaction an average US crypto holder goes through every year. Let’s take a look at an example and break down the tax consequences. Assume you purchased 1 BTC for $4,000 on March 1st, 2019. You sold this on an exchange for $9,000 on Oct 1st, 2019. This would generate a short-term capital gain of $5,000 ($9,000 - $4,000). This is short-term because the holding period (the duration you kept the asset) is less than 12 months. Short-term capital gains are taxed at ordinary income tax rates. Your specific tax rate is based on your filing status and overall income level, and ranges from 10% to 37%. In contrast, if you were to sell your 1 BTC on April 1st, 2020, that would generate a long-term capital gain of $5,000. Long-term capital gains are subject to preferential tax rates. This means that those gains are taxed at either 0%, 15% or maximum 20% rate. An easy way to save on taxes is to sell your cryptocurrency position after you hold it for more than 12 months. If you sell your crypto after holding it for more than 12 months, whether you make $2,000,000 or $20,000,000 in profits, maximum capital gain tax rate you would be subject to is 20%. In addition to capital gain taxes, at high income levels, you may also be subject to a 3.8% Net Investment Income tax.
- Purchasing goods and services using cryptocurrencies - When you purchase goods & services using cryptocurrencies, you are effectively selling your cryptocurrency in exchange for the product or service you receive. For example, lets assume you have 1 BTC purchased on March 1st, 2019 for $5,000. On November 1st, 2019 you want to buy some computer equipment listed on overstock.com using your bitcoin. The total cost of equipment is $6,000. By November 1st, your original BTC has appreciated to $6,000. When you use your BTC, which is worth $6,000 now, to purchase the equipment, that creates a taxable event. In other words, you are disposing an appreciated asset and gaining access to a new asset. In this case, $1,000 ($6,000 - $5,000) will be taxed as short-term capital gains.
- Margin liquidation - Margin trading is not a new phenomenon in the crypto world yet many users have a hard time understanding why they have to pay taxes when they fail to respond a margin call. In simple terms, margin loan is a loan provided by a crypto exchange/platform to invest in other cryptocurrencies. If your balance falls below the “Maintenance Margin Requirement (MMR)” and you fail to deposit more money to maintain your MMR, the exchange will start liquidating your assets to cover losses. This will follow the same tax principals applicable to sale of cryptocurrencies.
- Liquidation of collateral - Thanks to Decentralized Finance (DeFi) now you can borrow money by collateralizing cryptocurrencies. For example, platforms like Maker DAO allows you to collateralize cryptocurrencies like ETH & BAT and lends you Dai, a stable coin, you can cash out into USD, if needed. If the fair market value (FMV) of the collateral drops below the required ratio of 1.5X, the smart contract liquidates your collateral to cover the losses. This event is similar to a sale of a crypto asset and taxed as capital gains or losses.
These are some transactions which will fall under the “sell” category of the crypto question. If you are an investor, gains and losses arising from crypto trading activities are reported on Form 8949 and Schedule D. The next post will analyze what’s included in the “send” category of the crypto question.
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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.