If you earn regular revenue from your investment assets then that particular form of income is subject to capital gains taxes. Capital gains are the profits one yields from any kind of personal asset. This includes stocks, securities, and property. Since cryptocurrencies are considered property in many jurisdictions in Canada, the US and elsewhere, it is important for crypto enthusiasts to understand the implications of capital gains taxes. Others nations, like El Salvador, have made Bitcoin a national currency and do not consider it a personal property. So, there are no capital gains taxes for those residents.
It’s important to know that capital gains are not realized and counted as part of one’s income until they are sold. So you will not be subject to this type of taxation until you sell and take profit. For instance, if you buy Bitcoin and HODL (“hold on for dear life”) it long term in cold storage, you will not pay capital gains tax when tax time rolls around. But if you cash it out at anytime to take profits, that is when the tax will kick in.
Conversely, if you cash out and take profits and the price value of Bitcoin has declined so you have a negative net profit, you may be eligible to claim capital losses. This may be particularly relevant when dealing with highly volatile altcoins and for those that trade regularly or day trade.
Both short and long term investments may be subject to this form of taxation. Long-term investments typically have a lower rate of taxation than short-term investments.
What assets are included in capital gains?
Only personal assets contribute to capital gains. Unless an asset is a legitimate business expense, it is considered part of one’s income and therefore must be included when filing income taxes.
It is easiest to think of capital gains in terms of the property that earns an income. So, included in such assets are holdings like land and physical properties, machinery, vehicles, furniture, jewelry, patents, trademarks, shares, securities, mutual funds. If personal property is earning an income, it has the potential to be assessed as a capital asset.
This is also true for cryptocurrency assets in certain countries. As the popularity of crypto-assets continues to grow, so do the regulations surrounding them. So, as you continue to grow your portfolio, be sure you know what you might be responsible for. Canada’s regulators, consider cryptocurrencies a potential form of capital gains. Therefore, these crypto capital gains are taxable.
Let’s have a look at an example. If Alice buys 10 stocks in KLM for $400 and then sells them for $600 she has a gain of $200 x 10, or $2000. Because her gain is what she earned from her investment, and not the total cost. That $2000 however, will be added to regular income, and that total is her total taxable income.
However, capital assets do not include all of the property or items you own. Instead, they refer to only those that are earning or have real potential to earn an income. So if you own a very valuable car or jewelry, these are only considered capital gains if they ever earn you an income. Vehicles rarely increase in value, so this is not typically the case. However, something like jewelry can increase in value over time, and so could be considered an asset.
Understanding Captial Gains
Here are a few important concepts to understand when we are talking about capital gains:
- Capital Loss: A capital loss occurs when the asset decreases in value, and the proceeds from a sale are less than the purchase price. Basically, this is the opposite of gain, as it would count negatively towards your income.
- Investment Income: The essence of capital gains is that you have an asset that earns you income. Therefore, anything that earns an income is included, which includes passive income such as property, stocks, and bonds.
- Realized and Unrealized Capital: The sale of an asset demonstrates either realized or unrealized capital. It is realized if there are gains upon the sale and unrealized if the value of an asset has decreased.
- Short-term capital gains: Short-term gains express the increased value of securities held for one year or less. These gains are added to any other income and are taxed accordingly, based on the total annual income.
- Long-term capital gains: Long-term gains are often taxed at a lower rate than regular income. They are also usually slow growing investments. The rate of taxation of these gains will depend on several factors, including what country one lives in, and what their basic income tax bracket is.
- Mutual Funds: Annual gains from mutual funds are also counted as realized capital gains. The gains from the funds are distributed to shareholders. The gains are therefore distributed and so the total value of the fund drops depending on the distribution size.
Remember, gains only occur when a real (tangible) asset appreciates in value. If the asset depreciates, this is counted as a loss. The idea of including losses with gains was devised to encourage long-term investment in real assets and property.
Gains and losses are in some ways a relic of an agrarian society. The machinery necessary for farming was expensive and seldom retained its value, despite its importance. By allowing depreciation on machinery this could offset the capital gain earned on the value of the farmer’s land.
How are Capital Gains Calculated?
Taxation is relative to one’s income, which includes all of one’s assets. So when you hold assets, the gains made on these will contribute to your rate of taxation. A useful strategy for tax season is to sell assets in a year of lower income. This is particularly important for those who have multiple forms of active and passive income to pay attention to.
Moreover, it is important to know exactly at what point you move from one tax bracket to another. It is also important to remember income tax rates periodically.
Here is a Canadian example.
In 2019, Canada’s Income Tax Brackets were as follows:
- 15% on the first $47,630 of taxable income
- 20.5% on the next $47,629 of taxable income -on the portion of taxable income over 47,630 up to $95,259
- 26% on the next $52,408 of taxable income -on the portion of taxable income over $95,259 up to $147,667
- 29% on the next $62,704 of taxable income -on the portion of taxable income over 147,667 up to $210,371
- 33% of taxable income over $210,371
Notice how there are both large and small shifts from one income to the next. So if the sale of an asset will move your annual income from $45,000 to $50,000 you will move from the 15% to 20.5% bracket. So, if the sale can wait for a year with lower income, you may want to do just that.
How do you calculate gains for crypto trading?
With stocks and property, the regulatory structure is in place for reporting on gains and losses. Each year, stock brokers, investment banks and exchanges must send reporting documents to their users. These statements may be used when filing your taxes. However, in the cryptocurrency world, when trading can happen algorithmically 24/7, it may be seem more difficult to track the gains and losses from crypto, which in Canada and the US are treated as a property and not a currency.
All of the following events may trigger capital gains:
- Trading crypto for fiat currency
- Trading crypto for another cryptocurrency
- Spending crypto on a good or service
- Earning crypto as income (mining, staking, etc.)
Essentially, if your crypto turns to cash or earns passive income (i.e. in staking), in many regions this is a taxable event. It can get quite complicated if you are trying out multiple new crypto exchanges or trading apps, and have multiple trades going on simultaneously. Many crypto traders look to different types of crypto tax software to help them calculate their capital gains and losses.
One last note on crypto tax events: moving your Bitcoin from one Bitcoin wallet to another (same for other cryptos) generally does not trigger a taxable event.
The overall idea is that long-term investments provide a broader reach and more stable economy. If investors are constantly liquidating assets this contributes to volatility. While volatility has its value, governments need to incentivize large initial investments for slower longer-term gains. Make sure you have the information you need to know what is best for you in the short and long term.