Taxation is a complex topic. When cryptocurrency comes into the picture, it becomes more complex. And when crypto margin taxes are added, it becomes impossible sometimes even for tax professionals to handle.
However, as a crypto trader, we can’t ignore margin trading because of the benefits it provides. This is why it’s good for every crypto trader and investor to know the ins and outs of how crypto margin taxes work.
Before we talk about crypto margin taxes, let’s understand what margin trading is all about.
What is margin trading?
Margin trading is allowing traders to buy and sell using borrowed amounts or assets. This will provide you an increased opportunity to make money (or lose it). One should clearly understand the financial liabilities when you trade with ‘margin’ and understand various terminology associated with it. You may borrow amount to buy or an asset to sell. Maximum borrowed amount/asset is generally a fixed multiple of your available balance. This is called leverage – 10x leverage means, you can borrow 10 times the amount/balance you have in your account.
Cryptocurrency margin trading
Cryptocurrency margin trading allows traders to borrow money/cryptocurrency for trading on an exchange. Margin trading allows you to increase your gains by giving you access to more capital to bet big. The difference between the amounts you started your margin trade with (known as your opening position) and the time you closed your trade becomes your profit or loss. Traders use margin trading when they see a big potential gain in the market but do not have the capital to invest. Also, note that you will make a huge loss if prices go against your prediction.
Margin trading involves two options – Long or Short positions.
Making profit in a “Long” position:
Traders usually enter into a long position when they envision prices to rise. For instance, if you think BTC will rise, you can borrow money from an exchange, use it to purchase some BTC, and wait for the price to increase. Once your prediction becomes true and prices increase, you can sell the BTC and return the amount you borrowed to the exchange. The difference between the amount you borrowed and your profit from the increase in BTC becomes your profit.
Making profit in a “Short” position:
Going short is different, and normally used when traders predict a fall in the price of an asset. Let’s say you believe BTC prices will fall. In a short position, you will borrow BTC from the exchange and sell it at the current price. Once the price falls according to your prediction, you then buy the BTC back, at a lower price than you initially sold. The difference between the price you sold and the price you bought becomes your profit.
That’s the bright side of making a profit. However, if your prediction goes wrong and the market goes in the opposite direction
Taking loss in a ‘Long’ position:
You can either reduce losses by selling BTC in (Long scenario) and pay back the borrowed money or exchange will liquidate (sell) your collateral (your original amount) before the value of BTC goes below the loan amount. In this case, the trader will lose all his balance.
Taking loss in a ‘Short’ position:
Similarly, in the Short scenario, if the price rises, you either reduce losses by buying it back and repay the BTC borrowed, else the exchange will liquidate your collateral and pay itself before your account runs out of value needed to repay borrowed BTC.
Liquidations on margin trading
Liquidations are painful as they empty your account. Especially in cryptocurrency exchanges, the price could be very volatile and could fall by a huge percentage within a few minutes or hours leading to massive liquidations. This has happened multiple times on Bitmex, Binance, and other exchanges that provide margin trading capabilities.
To deal with such situations and protect traders against massive liquidations, exchanges like Binance are setting up Margin risk funds, introducing features like Auto-Deleveraging.
Tax implications: how crypto margin taxes work
Margin trading in itself doesn’t attract taxes: what you earn from your trade is what is taxable. Since the IRS treats crypto as “property”, the gains and losses you make are the only items worth taxing.
Scenario 1: Let’s say you went long by borrowing money to buy crypto. Once prices increase and you sell the crypto, your gain becomes a taxable event, in this case, a capital gain tax.
For example, you borrow $10,000 to buy one BTC from an exchange. Then after one BTC increases to $14,000, you sell it and return the $10,000 you borrowed to the exchange.
The difference, which is $4000, will attract a capital gains tax. However, remember that you also have to pay interest on the loan you took to the exchange. The amount you pay as interest, let’s say $300, should be deducted from your gains as expenses. This should be subtracted and the remaining amount, $3700 then treated to the right tax rate.
Scenario 2: If you go with a short position, that means you borrow crypto from an exchange, sell it, and later buy it when prices fall. The difference between the amount you sell and the amount you buy becomes your gain or loss when doing crypto margin taxes. This will attract a capital gains tax in the case of a profit. And if there are interest payments to the exchange, you can treat it as an itemized deduction.
What should you do if you’re margin trading crypto?
Crypto margin taxes are sometimes complex. In the two scenarios above, all you need to do is to keep proper records of your trades and sales. Then you can download your trade history from the exchange, upload to BearTax, and calculate your taxes.
BearTax supports Margin Trading Taxes on Kraken
BearTax support for margin trading is being rolled out for selective exchanges. We’ll be rolling out the support for other exchanges soon.
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There are more complex scenarios that may arise, especially for people who engage in advanced margin trading with different types of crypto assets. These trades become complex as you go such as liquidation events. If you have such a special case, reach out to us via the chatbox on our website and we would help you figure things out.