What are the key differences and why it matters?
Trading and holding cryptocurrency are two common activities. They have many similar characteristics and profits from each activity will generally result in taxable income.
This article will outline the different characteristics between trading and holding cryptocurrency, along with outlining the different taxation treatment. Finally, we include practical recommendations to consider.
It is important to remember that each individual trade between two different tokens is considered a taxable event (regardless if holding or trading cryptocurrency). This is because, on disposal of a token (whether a trade to another token, or sale to cash), all ownership rights of the original token are being disposed and passed to a new owner.
Cryptocurrency provides many other investment opportunities. Such as staking tokens, margin or leveraged trading, deFi, mining, passive investments and much more. These activities also have difference tax treatment which we have or will be discussing in separate articles.
By way of background:
- IRD have stated that “cryptocurrency is treated as property for tax purposes. There are no special tax rules for cryptocurrencies – ordinary tax rules apply”
- Our end of year tax guide, provides a summary of cryptocurrency tax and an end of year checklist
A taxpayer trading cryptocurrency is classified as being in business (taxed under CB1 of the Income Tax Act)
There is no one size fits all approach that distinguishes traders from holders. It depends on the nature of the activity and intention of the taxpayer. The key factors to consider are:
- Statements of the taxpayer about their intentions
- Nature of the activity
- The period over which the person engages in that activity
- The scale of operations and the volume of transactions
- The commitment of time, money and effort
- The pattern of activity
- The financial results
There is no set number of trades that would classify someone as a trader. Their overall activity (and factors above) need to be considered together. IRD has provided no guidance on what constitutes a cryptocurrency trader.
The actions of a trader are specific and clear. They have a trading strategy that is executed. They spend time researching and investigating trading strategies then actively apply and implement them. They are trading for a consistent period and not ad-hoc stopping and starting their activity.
A taxpayer holding cryptocurrency is classified as having property held on revenue account (taxed under CB3 or CB4 of the Income Tax Act).
Their cryptocurrency activity will be passive when compared to a trader. A holder’s activities may include strategies such as:
- Purchasing cryptocurrency using a dollar cost averaging method
- Rebalance of portfolio on a regular occurrence
- Holding for long term potential gains
- Less trading volume
- Less tokens traded
- Less exchanges used
- Less time, effort and commitment
Different cryptocurrency tax calculations may have significant implications of how much tax there is to pay (or refund), and the timing of tax payments (or tax refunds).
Valuation method of closing cryptocurrency tokens
Update March 2022: This position has now been updated due to new legislation introduced (retrospectively) which defines most cryptocurrencies as excepted financial arrangements. Please refer to the updated article here.
A cryptocurrency trader closing tokens held at year end are accounted for as trading stock. Like an ordinary business, trading stock is accounted for at the lower of cost price or net realisable value. Net realisable value can be measured as the market value from a reputable exchange.
By recording trading stock at the lower of cost price or net realisable value allows a cryptocurrency trader to claim any unrealised losses on closing trading stock.
For example, a trader purchases 100 ABC tokens for $30,000 on 1 January 2019. On 31 March 2020, the trader still owns 50 ABC tokens with a cost value of $15,000. However, the market value is now only $5,000. The trader is allowed a tax deduction to claim the unrealised loss of $10,000 and records the closing trading stock at $5,000.
A holder of cryptocurrency is required to value their closing cryptocurrency at original cost value of $15,000. No tax deduction can be claimed for until the token is ultimately disposed.
This valuation method of closing trading stock between traders and holders is a timing adjustment. However, it can have significant tax implications to claim any unrealised losses immediately for traders and subsequently reduce their tax liability.
For example, on 31 March 2021, the trader now sells the final 50 ABC tokens for $6,000. This results in the trader having taxable income of $1,000 (difference between last years closing stock of $5,000 and the sale price of $6,000).
The trader would claim a loss of $9,000 (difference between last years closing value of $15,000, less the sale price of $6,000).
Unrealised gains are generally not taxable until recognised (which involves a sale to $NZD, or trade to another token).
Claiming business expenses
A trader can claim expenses incurred in carrying on their business or incurred in earning their taxable activity. Compared to a holder, which can only claim expenses incurred in buying or selling their cryptocurrency.
For example, a trader can claim expenses such as training and development costs (relating to their cryptocurrency trading business), home office claim if they use part of their home as an office for their business, subscriptions for computer software programs, motor vehicle expenses to travel to cryptocurrency meet up groups.
Because traders are actively involved in business (spend more time and effort and have a larger scale of activity than a holder), it is likely that they will incur these types of expenses to run their business.
The expenses of a trader can be deducted against the trader’s taxable income.
Holders are limited in what expenses they can claim. This is because a holder’s activity is generally passive.
If a cryptocurrency holder was to attend a trading seminar it is unlikely the cost of the seminar as the expense (for trading) has no relationship or nexus to their activity (holding). Costs directly related to earning income are tax-deductible (for example, exchange fees).
Both traders and holders can claim any accounting fees related to advice for preparing their income tax return.
We recommend taxpayers:
- Understand whether their specific cryptocurrency activity is trading or holding cryptocurrency,
- Understand the tax differences between these two activities
- Have a clear tax strategy, so you know when any tax payments are due and how much these are likely to be
Finally, if you have previously been involved in a trading activity and are now changing to a holding activity there are also factors to consider which we have outlined here.
We are Chartered Accountants who prepare financial statements and income tax returns that involve cryptocurrency. We also provide personalised tax advice to your individual circumstances.
This is only our interpretation and has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.