Surprise: Bitcoins Are Taxable

A new client met with us recently. He was an early adopter of cryptocurrency and has been selling Bitcoins (BTC) and living on the sales for several years. And he was very surprised to learn that he has tax problems. He has not reported any of his sales.

Cryptocurrencies such as BTC, Ripple and Dash have a history of volatility and have been on a proverbial teeter-totter in the markets. Some investors (or speculators) who got into the cryptocurrency markets as dire warnings of a possible bubble collapse were issued by many central bankers are sitting on real or paper losses. BTC crashed in both 2011 and 2013. The 2013 plunge saw a 50 per cent decline in value in a single day. More recent crashes took place in December 2017 and January 2018. While a sale of cryptocurrency may make sense as a hedging strategy, it’s important to remember that tax burdens to Canada Revenue Agency (CRA) will be triggered. Our client rode all the ups and downs and sold throughout the years. He also lost some $2.3m of Bitcoin in the Mt. Gox exchange hack. But his net position is a massive gain and he has been living on the Bitcoins he cashed out.

Cryptocurrency that is earned is subject to tax when earned, in the same way as fiat currency, and must be reported on a tax return. You may also have a GST/HST filing obligation. While anonymity often is given as one of the selling points of cryptocurrency, Bitcoin is in some ways less anonymous than cash. Every transaction and every owner of the cryptocurrency is recorded in the blockchain. While it certainly is possible to use a fake name in setting up a digital wallet, as cybercriminals likely do, the trail of the currency can be traced through the blockchain.

The situation for our client as an investor in Bitcoins is very different. CRA says Bitcoin is considered by them to be similar to a commodity. The general rule is there is no need to pay tax on increases in value of a commodity (or other investment) as prices fluctuate. For our client just holding one BTC at the start of the year worth about $1,000 U.S. with a value of about $14,000 at the end of the year has no tax consequences. If the holdings exceed $100,000 CDN, there may be an offshore asset information reporting requirement (T1135), but no income tax is due.

In fact, since our client sold, or spent, Bitcoins to live on the tax there are tax consequences to him. The same is true of an investor who sold for any reason such as to hedge against a possible cryptocurrency bubble collapse, or for fear that the market may be manipulated by the 1,000 users who own 40 per cent of all Bitcoin. As soon as a sale takes place (and spending is a sale), there is a taxable transaction that must be reported to CRA. The flip side of the Bitcoin is that while an investor who bought at the peak of $19,800 US and saw the value decline to $14,000 US at the end of the year and even further in 2018, cannot deduct the loss until the BTC is sold or spent.

If an investor only dabbles in cryptocurrency, the sale will probably qualify as a capital gain, only 50 per cent of which is taxable (but only 50% of the loss is deductible, and only against other capital gains.) Our client, sitting on large increases in value, will face tax of close to 25 per cent (at top marginal tax rates) of the proceeds of sale. The exact amount of tax will depend on the cost when purchased. However, a heavy trader in Bitcoins will face tax as full income instead of the 50% capital gains rate.

Recent stories from the U.S. indicate that most participants in Bitcoins in the U.S. do not report their transactions to the U.S. Internal Revenue Service (IRS). This is tax evasion in both the U.S. and Canada and the tax authorities in both jurisdictions are aware of the phenomenon of cryptocurrency. In fact, reports state that the IRS has purchased software that can unveil a cryptocurrency user’s identity. The software analyzes a digital coin transaction and traces the units to their source. In other words, it follows a Bitcoin as it moves from BTC wallet to wallet. Authors of the tracing app claim that the software has already extracted information on 25 per cent of Bitcoin users, who account for about 50 per cent of all Bitcoin activity. And where the IRS goes CRA generally follows. Are you feeling lucky?

David J Rotfleisch, CPA, JD is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law firm. With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax litigation. www.Taxpage.com and david@taxpage.com.