Cryptocurrencies

Cryptocurrencies:

Cryptocurrencies are a type of digital currency created using computer algorithms. There are many cryptocurrencies, the most popular being Bitcoin.

Digital currency is electronic money. It is not available as bills or coins.

No single organization, such as a central bank, creates digital currencies. Digital currencies are based on a decentralized, peer-to-peer (P2P) network. The “peers” in this network are the people that take part in digital currency transactions, and their computers make up the network.

Do tax rules apply to cryptocurrency?

You bet, tax rules apply to digital currency transactions, including those made with cryptocurrencies! This means that digital currencies are subject to income tax under the Income Tax Act.

Basic concepts

The CRA generally treats cryptocurrency like a commodity for purposes of the Income Tax Act. Any income from transactions involving cryptocurrency is generally treated as business income, or as a capital gain, depending on the circumstance. Similarly, if earnings qualify as business income or as a capital gain, then any losses are treated as business losses or capital losses.

Before we can get to profit or losses, we need to understand the treatment of purchase and sale under the Income Tax Act.

What is a disposition?

This refers to the way you get rid of something, such as gifting, selling or transferring. In general, possessing or holding a cryptocurrency is not taxable. But there could be tax consequences when you do any of the following:

Sell or make a gift of cryptocurrency

Trade or exchange cryptocurrency, including disposing of one cryptocurrency to acquire another cryptocurrency

Convert cryptocurrency to government-issued currency, such as Canadian dollars

Use cryptocurrency to buy goods or services

Capital Gains/Losses

The income you get from disposing of cryptocurrency may be considered business income or a capital gain. For the purposes of this blog we are only discussing capital gains. For more information on business income from disposition of cryptocurrency, click here.

Capital gains from the sale of cryptocurrency are generally included in income for the year, but only half of the capital gain is subject to tax. This is called the taxable capital gain. Any capital losses resulting from the sale can only be offset against capital gains; you cannot use them to reduce income from other sources (such as employment income). You can carry forward your capital losses if you do not have any capital gains against which to offset those losses for the year, or any of the preceding three years.

Example: John was encouraged by friends to buy cryptocurrency as the next big thing to invest in. He decided to buy $1,000 worth of Bitcoin in 2018. In 2021 John found Bitcoin prices to be favourable and decided to convert his remaining Bitcoins back into Canadian dollars. The value of John's coins had increased by $1,000. John realized a profit of $1,000 on his purchase and sale of Bitcoins, and for tax purposes his taxable capital gains will be $500.

Trading cryptocurrency for another type of cryptocurrency

Generally, when you dispose of one type of cryptocurrency to acquire another cryptocurrency, the barter transaction rules apply. You have to convert the value of the cryptocurrency you received into Canadian dollars. This transaction is considered a disposition and you must report it on your income tax return.

Example: On July 30, 2018, James bought 100 units of Ethereum, which had a value of $20,600. For this purchase, James exchanged his 2.5061 Bitcoins, which were trading at $8,220 per unit on that day. For tax purposes the CRA considers this a disposition of James’ Bitcoins. James originally bought those Bitcoins for $15,000 and exchanged them for 100 units of Ethereum, at a value of $20,600, resulting in a capital gain.

It is calculated as follows:

$20,600 (fair market value of 2.5061 Bitcoins, at the time of transaction)

Less: $15,000 (adjusted cost base of 2.5061 Bitcoins, their original purchase price)

$5,600 capital gain

$5,600 capital gain taxed at 50% = $2,800 taxable capital gain

Example: If, on the other hand, the original purchase price of the 2.5061 Bitcoins had been $25,000, and at the time James exchanged them for 100 units of Ethereum they were only worth $20,600, he would have a capital loss. It is calculated as follows:

$20,600 (fair market value of 2.5061 Bitcoins, at the time of transaction)

Less: $25,000 (adjusted cost base of 2.5061 Bitcoins, their original purchase price)

$4,400 capital loss

$4,400 capital loss × 50% = $2,200 allowable capital loss

Cryptocurrency is the future of finance! At Softron Tax we can assist you with the tax rules of this innovative currency!