Due to the market collapse in 2023, currently, we expect many clients will have losses from cryptocurrency. This may be compounded further because of the bankruptcy of FTX, Celsius, and BlockFi and not to mention TERA and LUNA situation. What a wild ride we’ve all signed up for.
Because of the tax legislation, in nearly all cases, cryptocurrency losses will be tax deductible – like how in nearly all cases, cryptocurrency gains are taxable income.
Therefore, if you’ve made a loss of $100k, you will generally be able to offset the $100k loss against your other income and get a tax refund from the cryptocurrency loss.
In the 2023 year, John makes a loss of $100k from his cryptocurrency. He is an employee earning a salary of $125k pa. His employer deducts PAYE and pays it to IRD during the year (at his marginal tax rate). In total his employer has deducted the tax on the $125k salary (being $32,170) and paid this to IRD on his behalf.
The cryptocurrency loss of $100k is deducted from John’s salary of $125k. Therefore, he has taxable income of only $25k, but his employer has deducted tax on $125k. John’s tax on $25k of income is $2,875, but he has paid $32,170. Therefore, John is due a tax refund of $29,295.
It’s important to note that in this example, John has already paid the tax on his employment earnings to be able to get a tax refund. If you are not an employee or haven’t paid tax in the first place, IRD will not refund you tax (because you haven’t paid anything to get refunded).
The tax refund will be at your marginal tax rate. The same rate in which you pay tax. For more information check out our earlier article here.
A Strong Word of Caution
IRD does not like paying out tax refunds. Especially when the refunds are significant. This is compounded further when the refund is a one-off event.
IRD is likely going to ask questions and more information about your 2023 activity before releasing the tax refund and accepting the assessment of the cryptocurrency loss. This is not uncommon. We have had many clients with losses in the 2020 or 2021 year (from ordinary trading or leverage trading positions), and IRD will nearly always request further information.
If IRD requests further information, you haven’t done anything wrong or incorrect or are not subject to an audit. They only want to verify what is filed is in fact, correct and accurate.
What this means for You
Have your cryptocurrency records and information in immaculate condition that clearly captures every single transaction. This is the detail that IRD requires. They will request wallet addresses, trading records, fiat transactions etc. It’s very important that you have this information (plus, we will also need it as your accountants to prepare the information in the first place).
The reconciliation of your portfolio for tax purposes is a necessary but often difficult, painful and time-consuming process. It involves accounting for each transaction individually to ensure that the closing holdings are accurate and to ensure that any discrepancies are investigated.
The difficulty of this process can be exacerbated when you have multiple exchanges, a large volume of transactions and of tokens, as well as engaging in complex DEFI transactions such as liquidity pools across multiple chains.
It may also be worth considering if your complicated activity is really worth it. Have you bet the market? Or what is your competitive advantage within your cryptocurrency investment strategy.
To reduce complexity, it may be worth considering converting your portfolio to a stable coin or a single token, such as Ethereum, before the financial year ends. This decision needs to be considered with your wider investment purpose and inherit risk of transferring or trading, or moving cryptocurrency. Converting your entire portfolio to a single token, gives us a single figure to reconcile your portfolio too. This may not necessarily reduce IRD risk because if there are variances, there will still be manual adjustments required to reconcile the portfolio, resulting in unexplained transactions. However, it may reduce administration time and costs.
Bob begins the 2023 financial year with 30 different tokens. During the year, he trades significantly over many Exchanges and DEX’s. Before the end of the financial year, Bob converts his entire portfolio to USDC. As a result, the reconciliation process for the 2023 Financial year is more straightforward and potentially saves him administration costs.
Currently, many FTX users are unable to access their accounts. It is unclear whether access will ever be reinstated for these users. Missing trading information is another factor that can increase administration time when reconciling a portfolio.
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.