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, we can’t ignore margin trading as crypto investors because of the benefits it provides. Which 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.
Cryptocurrency margin trading
Cryptocurrency margin trading allows traders to borrow money 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 loss if prices go against your prediction.
Margin trading involves two options – long or short positions. 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 or loss.
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, which in this case, becomes lower than the amount you sold. The difference between the price you sold and the price you bought becomes your profit.
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 support for margin trading is being rolled out for selective exchanges and a closed group of customers. We’ll be rolling out the support for others 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.