This article outlines how a loss-making crypto trade may result in a combined profit (and subsequent tax to pay). Yes, this may seem strange, almost unfair, and the entire cryptocurrency portfolio including historical cost basis needs to be considered.
We have outlined an example below, where it appears John has lost money – buying 4,000 ABC tokens for $1 and then selling them at a loss of $0.50. However, the trading nature of cryptocurrency (selling one token for another), means that his prior disposal of a cryptocurrency token (to purchase the ABC tokens) also needs to be accounted for.
Transaction 1: John buys 10 ETH for $200 NZD each ($2,000 total) – buying is not a taxable event.
Transaction 2: Price of ETH increases to $2,000 per ETH. John sells 2 ETH (part 2.A) and receives 4,000 ABC tokens in return (part 2.B).
Part 2.A is a disposal of ETH and profit is calculated as the sale value less purchase cost.
Sale value = $4,000 (2 ETH at $2,000 each)
Purchase value = $400 (2 ETH at $200 each)
Profit = $3,600
Part 2.B is the purchase of 4,000 ABC tokens for $4,000 ($1 per ABC token) – buying cryptocurrency is not a taxable event.
Transaction 3: ABC token decreases to $0.50 per token. John sells his ABC tokens (part 3.A) back for 1 ETH (part 3.B).
Part 3.A is a disposal of ABC and profit is calculated as the sale value less purchase cost.
Sale value = $2,000 (4,000 ABC at $0.50 each),
Purchase value = $4,000 (4,000 ABC at $1 each)
Profit = – $2,000 (loss)
Part 3.B is the purchase of 1 ETH token for $2,000 – buying is not a taxable event.
John has made a loss on the ABC token ($2,000). However, the profit from selling ETH in the first place ($3,600) was larger than the loss. This is a key point we often find misunderstood.
For tax purposes, John has made a combined taxable profit of $1,600. This is the profit from disposing ETH in part 2.A above, less the loss from disposing the ABC token in part 3.A above.
John’s overall ETH holdings have decreased from 10 ETH (from 1) to now 9 ETH, but he has a taxable profit of $1,600 because he has realised the gain on selling 2 ETH (at the increase in value in part 2.A).
From a non-taxable position, if John didn’t trade, in this example:
- He would still own 10 ETH (instead of 9 ETH).
- He would have no tax to pay (because he would not have disposed any ETH).
- Therefore, he would be ~$2,500 better off (being 1 ETH valued at $2,000 plus 33% tax on $1,600 profit).
Contact Tim Doyle for a no obligation call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.
This material 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.