What are the differences between tax implications of crypto and stocks? When it comes to taxes, it seems to be one certainty of life, and when it comes to tax implications, both cryptocurrencies and stocks are no exception.
Yes, both stocks and cryptocurrencies are taxed under the heading ‘capital gains.’ However, the implications may vary according to the term of investment, that is, whether it is for the short term or a long term.
One of the most significant aspects when it comes to tax treatment between cryptocurrencies and stocks is that cryptocurrencies are considered to be a property as per the Notice of IRS 2014 – 2021.
It is just as stocks and shares certificates are considered to be intangible personal properties and are subject to taxes in terms of gains made.
Knowing these differences will enable you to know what taxable income you have made through the year and how exactly you should plan for paying your taxes.
- 8 Differences Between Tax Implications of Crypto and Stocks
- Which is More Tax Efficient – Crypto and Stocks?
8 Differences Between Tax Implications of Crypto and Stocks
With black market trading surging, crypto exchanges imposed AML requirements to prevent illegal transfers and drawing the righteous anger of the regulators. One of the biggest changes perhaps is in the tax treatment for the crypto traders.
Though crypto assets are taxed just like stock and shares, there are a few significant differences between the two. Here they are for your knowledge.
1. Purchase Implications
As for the cryptocurrency, if you simply buy crypto assets with US dollars and keep them in your wallet within the exchange itself or transfer it to your personal wallet, you will not owe any taxes to the government at the end of the year. This is according to the guidance listed on the Form 1040 tax return.
However, in the case of stocks, even if you only purchase them and do not trade them during the year for a profit it will surely have tax implications, because most of the stocks will pay some money in return in the form of dividends. This is also an income and will be considered as taxable by the IRS.
2. Using 401(k) Plan
In the case of cryptocurrency trading, you will need to pay taxes on each and every trade you make. Yes, you may think about using your 401(k) plan or Individual Retirement Account or IRA to avoid taxes but that will run you into surprising problems since the liability risks are different and significant.
3. Taxable Events
In the case of cryptocurrencies, you will be taxed when you make a profit during a transaction made during the year. It can be both short-term and long-term capital gain. Other taxable crypto events include mining, paying for goods and services, airdrops, staking and gaining, and swapping coins.
On the other hand, when you sell your stocks for a profit your income will be taxable but even if you earn interest on your investments, which are common in stocks, you will have to pay taxes.
When it comes to accounting or calculating taxes, it is not very easy when it comes to that related to crypto coins. This is because the volatility of the crypto market as well as the prices of the coins does not help much in determining the fair value of a specific crypto asset while making a buying or selling transaction computation.
On the other hand, calculating the taxes on stocks is quite simple and easy because the price factors are quite clear and transparent. More historical data and financial statements are available readily to arrive at a decisive fair value of each transaction made using any type of financial instrument or commodity.
5. Tax Calculating Methods
Ideally, average cost basis methods are used in calculating the taxes on crypto and stock trading. However, in the case of calculating taxes on stock trading, First In First Out or FIFO, Last In First Out or LIFO, or High Cost and Low Cost methods are used.
On the other hand, in the case of calculating taxes for crypto assets, usually FIFO, LIFO, and Minimization methods are used in order to determine the cost basis used, with FIFO being used a bit too frequently.
6. The Steps Followed
The steps followed in stock tax calculation involve finding a copy of trade confirmation received during purchasing the stock and adding the price and commission paid for the purchase. Dividends earned during the year are then added to the cost basis.
The total amount invested is deducted from the proceeds realized if there are any sales of stock made during the given period. Finally, the time of holding the stock is considered to determine the tax rate and the potential tax liability by multiplying the profit made by the capital gains tax rate as applicable.
Alternately, the steps to calculate crypto taxes include finding out the sale proceeds by multiplying the number of coins sold by the sale price and deducting it from the amount of investment. Short-term or long-term gain is also determined based on the date of purchase of the coins.
The other steps include importing all exchange trade history along with those made outside the exchange, verifying the data imported, determining the perfect accounting method, exporting the tax forms and calculating and including it in the final tax return.
7. Preparation for Tax Filing
Next, you have to follow the right taxation methods and implications depending on your specific trade so that you can include tax reductions, if any. Look for the provisions for losses and finally report your crypto income to the IRS or internal revenue Service.
As for stock trading, preparing for taxes includes maintaining proper books of accounts and getting them audited by a reliable audit firm so that computation of taxable income can be done precisely.
Next, collect all your necessary documents, choose a tax preparer, and schedule an appointment. Make sure that you round up all receipts, list all your personal information, and decide whether or not you should file for an extension if there is any need.
Also, in case of any refunds applicable, plan ahead and do not forget to carry a copy of the return of the previous year, just in case.
8. Reporting Options on Tax Return
In the case of stock trading, there are ideally two major types of stock options available namely, employer stock options and open market stock options. Employer stock options come in two other variants as well namely Incentive options and Non-Qualified stock options.
Until you actively trade or exercise these options you do not need to report them in your tax return. On the other hand, if you exercise these options then you will have to use Schedule D of form 1040 to report about them.
On the other hand, there are ideally five specific steps to follow to report your crypto options in your tax return. These are, calculating your capital gains or losses and creating tax Form 8949 and including that total on the Form Schedule D.
If you engage in self-employed activities, you will then need to use Schedule C instead. Complete the rest of it and finally file your taxes.
Which is More Tax Efficient – Crypto and Stocks?
Considering the financial market scenario of today, it can be safely said that there are two things that surely are not going to go out of business: one is cryptocurrency, especially Bitcoin, and the other is taxes.
If you are into investing then a question may naturally come to your mind – which among stocks and cryptocurrencies is a more tax efficient investment. Well, it calls for a fair bit of understanding.
The primary reason for it, which sadly is often overlooked, is the comparison of the impact and implications of taxes while investing in this particular digital asset and stocks.
From the viewpoint of taxes, cryptocurrencies, especially Bitcoin, have a significant advantage in comparison to stocks.
This is because cryptocurrencies allow you to harvest losses on taxes much more assertively and productively in comparison to stocks. This, in turn, results in higher savings, which, typically, can be reinvested in your portfolio.
However, when you consider capital gains only, there seem to be no real differences in tax implications on stock gains and crypto gains. Crypto assets like bitcoin are considered to be a ‘property’ by the IRS according to their Notice 2014-21.
This means that holding crypto coins in the form of an investment will be subjected to similar capital gain tax implications as in the case of stocks and other securities.
However, if you consider capital losses, then cryptocurrency will offer tax loss harvesting much more frequently.
Once again, the reason behind it is that it is treated as a property and is not subject to wash sale just in the case of stocks and other securities which prohibits from claiming losses made from such sales.
Stocks and securities are sold at a loss in wash sale and then an identical stock or security to a large extent is bought within a 30-day time period before or after the initial disposal.
In the case of cryptocurrencies, you do not have to wait for that long a period, which is good for harvesting your tax losses, if any.
Typically, when the amount invested is more than the value of your portfolio, or is in ‘red’ as it is termed more commonly, you can make significant benefits by selling your investment in order to harvest tax losses.
When you can harvest tax losses without any restrictions more frequently, it will reduce your tax bill overall and the amount saved can be reinvested in your portfolio so that the value of it grows.
However, there is one caveat that you should keep in mind. According to the current guidance related to cryptocurrencies, continual tax loss harvesting is neither denied nor openly permitted by bypassing the 30-day window even though it is exempted from wash sale rules being considered a property, unlike stocks and securities.
Also remember that, any abusive practices may result in a ‘substance over form argument’ which will disallow losses.
Loss harvesting may sound a bit counter intuitive for your portfolio which will go through frequent ups and downs. However, in the pretext of the crypto vs stocks battle, crypto seems to be the clear winner in tax implications and treatments.