Updated September 6th 2018 to add in more information about tax software you help you keep track of your liabilities.
In recent years, bitcoin and other digital currencies have been subject to intense scrutiny by governments and tax agencies around the world. The concept of a blockchain that produces valuable and scarce cryptographic tokens in exchange for maintaining the network is a radically new idea which has taken some time for authorities to grasp.
As with any other asset or store of value that has the potential to earn a profit, tax needs to be paid on the gains. The way that bitcoin profits are treated varies greatly around the world – largely depending on whether it is classified as an asset, a currency or a commodity.
In Australia, bitcoin (and similar cryptocurrencies) are treated as assets. This article takes a deeper look at the tax implications of buying and selling bitcoin in Australia, and what you need to know. Your transactions can be subject to a range of different taxes depending on the reasons why you are using bitcoin, and how long you own it for.
Activities that result in tax obligations:
The Australian Tax Office (ATO) is responsible for collecting taxes, and pursuing people who don’t pay their taxes. On their website, the ATO identifies 5 potentially taxable scenarios for individuals interacting with cryptocurrency, and 2 scenarios where businesses that handle cryptocurrency need to understand their tax obligations.
For individuals, capital gains tax (CGT) is the most common levy that they are liable to pay. Taxes are only payable when an asset is sold. The following types of transactions may be subject to CGT:
- Selling or gifting bitcoin.
- Trading or exchanging bitcoin (including for another cryptocurrency).
- Converting bitcoin into fiat currency.
- Purchasing goods or services with bitcoin.
Crypto to crypto transactions – this is treated as selling one CGT asset (an asset that is subject to CGT) and purchasing another CGT asset. The values must be calculated in Australian Dollars.
For example: let’s say that you purchased 5 bitcoins for a total of $10,000 ($2,000 each), then traded 1 bitcoin for 25 ether a year later. At the time of sale, the 25 ether are worth a total of $14,000. In this instance, you would need to pay tax on the $12,000 gain ($14,000 – $2,000). If you dispose of the ether later on, the cost of your 25 ether would therefore be $14,000.
“If the cryptocurrency you received cannot be valued, the capital proceeds from the disposal are worked out by using the market value of the cryptocurrency you disposed of at the time of the transaction.”
Investing in cryptocurrency – if you buy bitcoin (or any other crypto for that matter) with the intention to sell it for more than what you paid, then you are required to pay CGT on any gains. If you hold onto your bitcoin for 12 months or more, you may be entitled to a discounted CGT rate.
If you sell your bitcoin for less than what you paid, then you are able to offset this loss against future capital gains. However, you cannot deduct a net capital loss from other income such as wages. It is important to keep detailed records about when you purchased the bitcoin, when you sold it and the prices you paid or received in each transaction.
Personal use – if you purchase crypto with the intention of using it for personal ends (such as experimenting with developing dApps, as an enthusiast, or to immediately make transactions), and the total value of cryptocurrency purchased is under $10,000 then you may be exempt from paying capital gains tax.
As noted on the ATO website, cryptocurrency is not a personal use asset if it is acquired, kept or used as an investment, in a profit-making scheme, or in the course of carrying on business. The relevant time for determining whether an asset is a personal use asset is at the time of disposal, and the longer the period of time that you hold a cryptocurrency, the less likely you are to be exempt from CGT.
For example: if your local hairdresser is offering a 25% discount for transactions made in bitcoin, and you purchase bitcoin to get the discount, then you can use the personal use exemption. However, if you are already holding bitcoin as an investment, and you spend it on getting a haircut to enjoy the discount, then you will likely be subject to CGT.
Loss or theft of cryptocurrency – if you lose your private keys, or your bitcoin is stolen, then you may be able to claim a capital loss. To claim a capital loss, you need to be able to provide some kind of evidence such as your wallet address, the cost you incurred to acquire the lost or stolen crypto, or that the wallet was controlled by you before you lost it.
Forks and chain splits – when a new token is created as a result of a fork, the new token did not cost you anything, and therefore has no acquisition value in the eyes of tax law. However, any gains that you make from selling this token are taxable. For businesses, new tokens are treated as trading stock, and must be accounted for at the end of the financial year.
Traders, miners and exchanges are examples of businesses that are involved in cryptocurrency. However, the definition of what constitutes a business in this instance is quite broad. The Australian Tax Office offers the following guidelines to help determine whether you are an individual or a business dealing in crypto. To be carrying on in business, you will usually:
- Carry on your activity for commercial reasons, or in a commercially viable way.
- Undertake activities in a business-like manner.
- Prepare accounting records, and market a business name or product.
- Intend to make a profit, or genuinely believe that you will make a profit, even if you are unlikely to do so in the short term.
Using cryptocurrency for business transactions: if you receive or spend bitcoin as payment in exchange for goods or services, then you need to account for these transactions as you would for any other non-cash payment. They are treated in a similar way to barter transactions.
Paying salary or wages in cryptocurrency: generally, employees that wish to be paid in bitcoin instead of dollars will sign a salary sacrifice agreement. This contract documents the terms upon which an employer can reduce or remove the payment of cash in exchange for some kind of non-cash benefit (in this case, cryptocurrency). When such an agreement is signed, the payment of cryptocurrency is a fringe benefit, and the employer is subject to the Fringe Benefit Tax Assessment Act 1986.
In the absence of this agreement, the “employer will need to meet their pay as you go obligations on the Australian dollar value of the cryptocurrency it pays to the employee.”
Record keeping is paramount!
Once you understand your obligations, it is important to maintain detailed records of all crypto-related transactions that you undertake. Not only will this make it much easier for your accountant, but it can also help you to pay less taxes. Here are a few tips to help:
- Remember to record every expense incurred as a result of buying and selling bitcoin (fees, foreign currency exchange, broker commissions, bank deposit charges, accountant fees etc.). This can be deducted from the tax that you need to pay.
- Whenever you buy or sell bitcoin, make sure to get an accurate record of your net cost in Australian dollars, when the transaction occurred (timestamps can help here), and who was on the other end of the transaction (even if it’s just a record of their public address).
- You only pay capital gains tax when you sell. If you’re planning on holding for a profit, consider waiting for more than 12 months to reduce the rate of capital gains tax that you need to pay. For individuals, this represents a 50% CGT discount!
- When you do sell for a profit, don’t forget to set aside a proportion of your earnings for paying taxes.
- Most exchanges allow you to export a CSV file of your transaction activity. This makes it much easier to determine how much you have gained or lost.
- There are apps like bear.tax, bitcoin.tax and cointracking.info which can automate away the process of collecting, calculating and preparing records for tax returns.
Strategies to help pay for your gains
When the price of bitcoin is rising extremely fast, it is easy to get caught up in the hype and forget about paying taxes. So how can you keep on top of your obligations in this fast-paced market?
Every time you make a transaction with cryptocurrency, you need to calculate the amount of profit or loss, and set money aside to pay for capital gains tax on that amount. It is a good idea to open a separate bank account for this purpose to avoid the temptation of spending or reinvesting your taxes.
Example: Johnny purchases 1BTC for $1,000 in January 2017. He then sells 0.5BTC for $2,000 in August 2017. Johnny earns an annual income of $20,000, so his capital gains tax rate is 19%. When Johnny sells 0.5BTC, he makes a profit of $1,500 ($2,000 – ($1,000 * 0.5)) and therefore sets aside $1,500 * 0.19 = $285 in a separate account to pay for capital gains tax.
How do I determine the cost price if I’ve bought bitcoin at multiple prices?
This is an interesting question, which has sparked a great deal of confusion among investors. It all comes back to whether you calculate the cost of your bitcoin sold using the FIFO (first in, first out) or LIFO (last in, first out) method.
For example, let’s say that you purchased 1BTC in January 2017 for $1,000 and 1BTC in June 2017 for $3,000, then sold 1BTC in August 2017 for $4,000. Using the FIFO method, the cost of your bitcoin sold in August 2017 would be $1,000 ($3,000 realized capital gain). Under the LIFO method, your cost price would be $3,000 ($1,000 realized capital gain) based on the most recent purchase price.
This simple distinction can make a huge difference to the amount of tax that you owe.
The Australian Tax Office advises investors trading shares to use the LIFO method to prevent “taxpayers from manipulating the period that shares have been held at risk by buying new shares and choosing to sell other shares from their portfolio held for a longer period.”
However, it is unclear whether this rule also applies to cryptocurrency transactions, as the LIFO method is applied here for the purpose of administering the holding period rule.
As a shareholder, it is impossible to differentiate one ordinary share of a company from the next. Unlike shares, units of bitcoin (satoshis) are distinct from one another. When an investor purchases bitcoin in multiple transactions over time, these units are held in their wallet as separate groups of bitcoin (unspent transaction outputs/UTXOs). When bitcoin is sold from his/her wallet, it is not necessarily the first or last UTXOs that are sent. It is therefore hard to say which method should be applied.
If you are unsure whether to use the FIFO or LIFO method, consult your accountant for tax advice, and make sure that you are consistent with whatever method you decide to use. As time progresses, the legal framework around cryptocurrency tax will become clearer. However, you don’t want to be the one getting caught out.
Do I really need to set aside money for tax on crypto to crypto transactions?
Unfortunately, the answer is yes.
As we previously mentioned, this is viewed in the eyes of tax law as a transaction between two CGT assets. Before trading one cryptocurrency for another, make sure that you can afford to pay any capital gains taxes on this transaction, and set money aside to do so. If you don’t have the money to pay for the tax, it is a good idea to consider selling some of your crypto to cover the amount of tax owing – or avoid making the transaction.
Example: Johnny purchases 1BTC in January 2017 for $1,000. During June 2017, he trades his bitcoin for 10ETH which had a value of $400 each at the time ($3,000 capital gain). At a 19% tax rate, Johnny owes $570 in capital gains tax from this transaction. Since he doesn’t have this amount of money spare, Johnny decides to sell 1.425ETH (for $570) to cover his tax liability. Johnny is a sensible investor.
Capital gains tax is a two-way street
If you lose money from your trades, this is considered a capital loss. You can offset capital losses against capital gains to reduce your tax burden. “However, the net capital loss is unable to offset tax on any other income, and can only be ‘carried forward’ to offset capital gains in future income years.”
Crypto-tax software can make your life much easier
If you have made a significant amount of transactions during the previous financial year, the process of calculating your costs and tax liabilities can become quite cumbersome. This is where software tools and apps really come in handy. The following services integrate directly with exchanges and automate away the calculation of your gains/losses. They can also be used to work out the difference in tax owing under the FIFO/LIFO methods.
- Bear.Tax is great for people who only need to account for a few transactions. Prices begin at $0.99/year for up to 20 transactions, with other packages available for higher volume clients.
- Bitcoin.Tax partners with a handful of accounting firms, and offers a very affordable service for traders and people with higher transaction volumes. Pricing begins at $29.95/year for individuals that have made less than 10,000 trades.
- CoinTracking.Info is a powerful set of tools that can do much more than simply calculate and prepare tax returns. They offer a range of analytics tools that are very useful for both amateur and professional traders. They also provide a free plan for up to 200 transactions.
If you are unsure, get help from the experts
When filing tax returns, it is important to get it right. Tax law is always subject to change, and the consequences of making mistakes can be quite significant. If you are dealing with larger amounts of money, it is important that you speak with qualified professionals that know what they are talking about, and have a specific understanding of cryptocurrency-related matters.
Disclaimer: this article is accurate to the best of our knowledge at the time of writing. However, we are not accountants, and this is not financial advice. We cannot be held responsible for any actions that you take as a result of reading this article. We recommend that you seek professional advice if you’re unsure about how to proceed.