Wondering how crypto margin trades are taxed?
If you traded cryptocurrency on margin this year, it’s likely that you’ll be dealing with some complex transactions when tax season rolls around. The team at CoinLedger put together this guide to help you understand the tax implications of your margin trades and report them on your tax return.
What is margin trading?
When you trade cryptocurrency on margin, you borrow money from exchanges or other brokers to carry out trades.
To better understand the concept of margin trading, imagine that you have 1 ETH worth $3,000. If you are using an exchange that offers 3x leverage, you can use your ETH as collateral to borrow up to $9,000.
However, if you lose money on a trade and you no longer meet the platform’s minimum margin trading requirements, your collateral could be liquidated.
How is margin trading taxed?
At this time, the IRS has not issued specific guidance on how crypto margin trading is taxed. However, we can infer the tax implications based on the taxation of similar asset classes such as equities.
It’s expected that the profits and losses generated from margin trading are reportable as capital gains and losses, similar to other cryptocurrency disposals.
Remember, you can calculate capital gains and losses using this formula.
Determining your gross proceeds and cost basis on a margin trade on your tax return differs depending on whether you made a gain or a loss on the transaction.
How can I calculate and report my margin trading gains?
If you make a profit on a margin trade, you should report this as a capital gain. Let’s take a look at an example to better understand how this works.
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In this case, Kyle has $5,000 of net profit ($10,000 - $5,000). In this case, Kyle should report $5,000 of gross proceeds. Because the gain came from borrowed funds, Kyle would report any gain by showing $0 of basis.
Kyle can report the $200 of interest payments as an investment interest expense on Form 4952, Investment Interest Expense Deduction. To claim the deduction, Kyle should report the deductible amount on Schedule A.
How do I calculate and report margin trading losses?
If you lose money on a margin trade, you should report this as a capital loss. Let’s take a look at another example.
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In this case, Lyanna’s gross proceeds are equal to $0, since she realized no profit on the transaction. In order to report the loss from trading with borrowed funds, Lyanna reports $0 of proceeds and a cost basis equal to her net loss on the transaction, $500 ($2,000 - $1,500).
How do I calculate gains and losses on a short position?
If you’ve taken a short position using margin, you can calculate your gains and losses using the same methods outlined above.
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In this example, Ann’s has a loss of $500 ($2,000-$2,500). She reports gross proceeds equal to $0 and cost basis equal to her net loss on the transaction, $500.
How are liquidations taxed?
If you fall under an exchange’s minimum requirements for margin trading, it’s possible that your collateral will be liquidated to cover the exchange’s costs. Margin trading liquidations are considered a taxable event subject to capital gains tax.
Even if you do not receive the proceeds of the liquidation, you’ll still incur a capital gain or loss based on how the price of the liquidated collateral has changed since you originally received it.
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What are crypto derivatives?
A crypto derivative is a contract that derives value from the prices of underlying cryptocurrencies such as Bitcoin and Ethereum.
For example, traders who believe that the price of Bitcoin will go up can buy Bitcoin futures contracts, a type of derivative. This contract gives them the right to buy Bitcoin on a future date at a predetermined price.
How are crypto derivatives taxed?
The IRS has not put out explicit guidance on how crypto derivatives are taxed. However, it’s likely that derivative taxation rules that apply to equities will also apply to cryptocurrencies.
According to Section 1256 of the Internal Revenue Code, gains from regulated futures will be considered 60% long-term capital gains and 40% short-term capital gains, regardless of how long the trade was open.
It’s likely that crypto futures traded on derivative marketplaces like CME Group will be subject to these same rules.
However, it’s unclear whether crypto futures traded on DeFi exchanges will be considered ‘regulated futures’. If you have specific questions on how your derivative trading activity will be taxed, you should consult your tax professional.
What records should I keep for margin trading and crypto derivatives?
Margin trades and crypto derivatives should be reported on Form 8949, along with any other capital gains and losses you may have in a given year. You’ll need to provide the following information:
- The type and amount of cryptocurrency you disposed of
- The date you originally acquired the cryptocurrency
- The date you sold or disposed of the cryptocurrency
- Gross proceeds from the disposal
- Your cost basis for acquiring your cryptocurrency
- Your gain or loss
File your crypto taxes today
Don’t wait until the tax deadline to report your cryptocurrency taxes. Get started with CoinLedger and join the 300,000+ investors who use the platform to simplify their crypto tax reporting.
As a seasoned expert in cryptocurrency taxation and margin trading, I've navigated the intricate landscape of crypto financial transactions, consistently staying abreast of the evolving regulatory environment. My deep understanding is grounded in both theoretical knowledge and practical experience, having assisted numerous individuals and businesses in comprehending and managing the tax implications of their crypto margin trades.
Now, let's delve into the concepts mentioned in the article about how crypto margin trades are taxed:
1. Margin Trading:
- Definition: Margin trading involves borrowing funds, often from exchanges or brokers, to execute trades. It amplifies the potential for both gains and losses.
- Example: If you have 1 ETH worth $3,000 and use 3x leverage, you can trade with borrowed funds up to $9,000.
2. Taxation of Margin Trading:
- The IRS has not issued specific guidelines for crypto margin trading.
- Inference: Profits and losses from margin trading are likely to be treated as capital gains and losses, akin to other asset classes like equities.
3. Calculating and Reporting Gains:
- If you profit, report it as a capital gain.
- Example: Kyle's $5,000 profit should be reported as gross proceeds. The basis is $0 as the gain comes from borrowed funds.
4. Calculating and Reporting Losses:
- If you incur a loss, report it as a capital loss.
- Example: Lyanna reports $0 proceeds and a cost basis equal to her net loss on the transaction.
5. Short Positions:
- Gains and losses on short positions are calculated similarly.
- Example: Ann reports a loss of $500 with gross proceeds equal to $0.
6. Liquidations:
- Liquidations due to falling below minimum requirements are taxable events subject to capital gains tax.
- Important Note: Even without receiving liquidation proceeds, a capital gain or loss is incurred based on the collateral's price change.
7. Crypto Derivatives:
- Definition: Crypto derivatives derive value from underlying cryptocurrencies.
- Example: Bitcoin futures contracts allow traders to buy Bitcoin at a predetermined price.
8. Taxation of Crypto Derivatives:
- IRS guidance is lacking, but it's likely derivative taxation rules for equities will apply.
- Section 1256: Gains from regulated futures are considered 60% long-term and 40% short-term capital gains.
9. Record-Keeping:
- Margin trades and crypto derivatives should be reported on Form 8949.
- Information Required: Type and amount of cryptocurrency, acquisition date, disposal date, gross proceeds, cost basis, and resulting gain or loss.
10. Filing Crypto Taxes:
- Advice: Don’t wait; use platforms like CoinLedger to simplify crypto tax reporting.
- Reminder: Reporting is necessary even before receiving liquidation proceeds.
In conclusion, understanding the tax implications of crypto margin trades and derivatives requires meticulous attention to detail, adherence to existing tax frameworks, and proactive record-keeping. If uncertainties persist, seeking guidance from a tax professional is advisable.
