The 2022 financial year has had wild price fluctuations. We all experienced record price highs before Christmas, and then a significant pullback in prices in early 2022.
No doubt, some taxpayers have traded at the top of the market, triggering a significant profit, and then purchased (due to the trading nature) other cryptocurrency tokens. Those new tokens may be only a fraction of the value they were purchased for. This decrease in value may not be tax-deductible…
This article’s purpose is to ensure you don’t pay more tax than necessary in the 2022 financial year and outlines what to consider as 31 March 2022 approaches.
We always recommend making decisions from a strong business, commercial, and investment perspective, before considering any tax consequences (good or bad). In our experience making decisions from a tax perspective misses the bigger picture or opportunities, and likely has elements of tax avoidance risks involved.
Cryptocurrency Trading vs Cryptocurrency Investing
Firstly, it is important to determine if you are a trader or an investor. Our earlier article outlines the differences between these distinguishments and we recommend you understand which classification you fit into because they have different tax treatment, especially in the current market conditions.
Cryptocurrency Traders – Closing Stock Valuation Method
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’s closing tokens held at year-end are accounted for as trading stock. Like an ordinary business, the 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.
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 on 31 March.
For example, a trader purchases 100 ABC tokens for $30,000 on 1 January 2022. On 31 March 2022, 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.
Cryptocurrency Investors – Closing Stock Valuation Method
A holder (or investor) of cryptocurrency is required to value their closing cryptocurrency at their original cost value.
Using the same example above, an investor purchases 100 ABC tokens for $30,000 on 1 January 2022. On 31 March 2022, the investor still owns 50 ABC tokens with a cost value of $15,000. However, the market value is now only $5,000. The investor is denied a tax deduction of the unrealised loss of $10,000. His closing value is cost value or $15,000. No tax deduction can be claimed until the tokens are ultimately disposed of.
Summary of the differences in valuation method
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 2023, the trader now sells the final 50 ABC tokens for $6,000. This results in the trader having a taxable income of $1,000 (the difference between the trader’s last year’s closing stock of $5,000 and the sale price of $6,000).
Compared to an investor, who would claim a loss of $9,000 (the difference between the investor’s last year’s closing value of $15,000, less the sale price of $6,000).
Unrealised gains are generally not taxable until recognized (which involves a sale to $NZD, or trade to another token).
What can you do to prepare?
- Determine if you are a trader or an investor so you know how your closing stock is accounted for (lower of market value or cost value, of cost value).
- If you are an investor, consider your strategy, intention, and decision-making process. There may be a tax advantage if you dispose of tokens before 31 March 2022 when the market value is less than your purchase value. Therefore, the loss is being realised and deductible for tax purposes in the 2022 financial year.
- Important: The sale of a cryptocurrency token (triggering a taxable loss) then immediately buying it back (at the lower cost value), without commercial reasoning has elements of a tax avoidance arrangement. A tax avoidance arrangement “means an arrangement, that directly or indirectly has tax avoidance as its purposes or effect… if the tax avoidance purpose or effect is not merely incidental”. Be aware that NZ has different cryptocurrency tax regulations compared to other jurisdictions which may allow cryptocurrency tax-loss harvesting. For more information refer to our tax-loss harvesting article.
- If you are a trader, consider tokens that may not have a reliable exchange value (measured on CoinGecko or CoinMarketCap). For tokens to be accounted for at market value, the market value needs to be able to be verified, and reliable. Some tokens with smaller market caps may not have sufficient information or price data to do so.
- Consider staked tokens or liquidity pool tokens where a placeholder token is received instead of the deposit to the pool/staking. The placeholder token received is unlikely to have a market value that can be reliably measured on 31 March 2022 – only the actual token staked or in the pool. Therefore, unstaking or removing tokens from the pool may be required to use the closing stock at market value concession.
- NFT’s are unlikely to have a reliable market value on 31 March, due to their non-fungible and unique nature, therefore, they will likely be accounted for at the original cost value.
Contact Tim Doyle for a 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.