The ins and outs of income tax when using cryptocurrencies

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Cryptocurrencies has developed into a sizzling topic over the last 2 years. Trending digital currencies such as Bitcoin and Ethereum have increased in value resulting in significant market capitalization, transactional use and legitimacy. With the rise of cryptocurrencies, regulators and taxation authorities have taken notice.

Here are the key tax questions and answers, investors and others transacting in cryptocurrencies need to know:

1) Does the Canada Revenue Agency (“CRA”) expect Canadian taxpayers to report realized gains and losses in cryptocurrency?
Yes, the CRA has indicated that it considers cryptocurrencies as commodities for income tax purposes. Therefore, it considers income from transactions in digital currencies to be a taxable event. This treatment applies to all taxpayers including corporations, individuals and trusts.

2) How does one determine if realized gains and losses from cryptocurrency are on account of income or capital?
If the taxpayer is in the business of buying and selling commodities such as Bitcoin, any gains or losses would be treated as regular income and not on account of capital. Any income is 100% taxable. Trading losses would be 100% deductible against all types of income.

Cryptocurrencies such as Bitcoin that are purchased for investment purposes will be treated as capital property. Gains and losses will be treated as a capital gain or capital loss. Simply put, it is no different than buying and selling shares for Apple Inc. For example, if one purchases a Bitcoin for $10,000 CAD and sells it for $12,000 CAD, the $2,000 gain will be treated as a capital gain. Capital losses in trading cryptocurrencies are only deductible against capital gains whether from digital assets or any other source.

3) Are unrealized gains in cryptocurrencies taxable?
No – if one is holding digital currency, which has appreciated in value, this would not be a taxable event. It is only taxable when the digital coin is disposed of.

4) For income tax reporting purposes, how are transactions in digital currencies converted into Canadian dollars?
Income and losses are calculated based on the exchange rate at the time of the transaction. Thus, if a Bitcoin was bought at a price of $10,000 CAD, this would the historical cost. The sale proceeds are converted into Canadian dollars at the time of sale so if the sale proceeds are $15,000 CAD, then the investor will report an income gain of $5,000 CAD.

5) If cryptocurrency is used to purchase items, for example, a car, how does this effect income taxes?
This type of transaction is considered a disposition or sale of cryptocurrency and is no different than selling it for cash. If the digital currency is used to purchase a car, and it is worth more now than when it was initially purchased, then for income tax purposes you will have a taxable gain on account of disposing of the cryptocurrency. The opposite applies if there is a loss.

If the car costs $20,000 CAD and the Bitcoin used to buy the car was originally purchased for $10,000 CAD, then there is a $10,000 CAD gain for income tax purposes.

6) What happens when one type of cryptocurrency is traded for another? For example, I swapped my Bitcoin for a new type of currency?
Again, this is similar to selling it for cash. Any gain on the transaction will be subject to income tax.

7) What happens when a taxpayer buys digital currencies at various points of time? How is each unit’s cost determined? For example, “I bought 1 Bitcoin for $5,000 CAD and another for $10,000 CAD. I then sold one Bitcoin for $15,000 CAD.” What is my cost base for calculating the gain?
The weighted average method is used to determine each units historical cost. In this case, it would be $7,500 CAD per Bitcoin.

8) What happens when a contractor receives digital currency instead of cash for their services?
This is considered business income the same way one would treat being paid in cash. Digital currency earned would be exchanged into Canadian dollars for the purposes of determining taxable income. Depending on the amount of fees earned, HST may be required, and would be charged by the contractor.

9) How are digital currencies earned via cryptocurrency mining treated for income taxes?
Coins received from mining are taxable as business income. It should be noted that expenses sustained in the process of cryptocoin mining, are also deductible for tax income purposes. Examples of mining expenses are hardware and software costs, rent and electricity.

10) Anything else I need to be worried about?
Taxpayers in Canada need to report all their foreign assets to CRA if their total aggregate cost exceeds $100,000 CAD. Cryptocurrencies deposited in a platform based outside of Canada are included in the calculation of foreign assets. This is the case even if no income was generated from the digital currency.

Not reporting these digital assets could result in significant interest and penalties.

For more on cryptocurrency, read the Zeifmans Real Estate Team’s latest blog on the future of buying and selling real estate with cryptocurrency.

If you have any questions, please feel free to reach out to David Posner, Jonah Bidner and/or Ahmad Aslam.