An anonymous poster on Reddit’s /r/taxes subreddit asks: “Did I ruin my life by trading crypto?” After an initial investment of $5,000, this “clueless college kid” was able to turn his cryptocurrency portfolio into $800,000 at the peak of last year’s cryptocurrency bull run.
However, his portfolio is now worth only $125,000, and he estimates that he owes $400,000 in capital gains taxes, effectively bankrupting him. The poster, a college from California, claims that he won’t be able to afford the taxes since he only works part-time at Barnes & Noble, earning $12 an hour.
How was he able to turn $5,000 into $800,000? He started by buying Ethereum (ETH) in May of 2017, when ETH was trading around $200. After that:
Well, I went down the rabbit hole and struck gold a few times, hitting 10x's on multiple alt coins... I brought my 5k initial all the way up to a $880k portfolio in December 2017. Now I should have listened. I should have cashed out, yes. Once I hit $1 million I was going to... I would have been set. And then, JUST like that the market tanks going into the new year.
Just like that, his gains disappeared. As he says above, he didn’t sell towards the top. Instead, he diversified into “more than a few bad ICOs to start 2018.” It’s possible these ICO’s locked up his contributions for months, and by the time the tokens were launched, might’ve already been in panic mode.
This post highlights a big problem with the cryptocurrency market: there are no clear guidelines for taxation. In traditional markets, there are clear rules. This means your broker will tell you every year, around tax season, how much you owe Uncle Sam. Cryptocurrency, on the other hand, is the wild west, and there are no clear cut laws. This means that the poster above didn’t plan to pay any taxes, and only realized his fate when he received a tax form from Coinbase.
The Crypto Tax Nightmare
Despite the poster’s pain, this example should be a cautionary tale for everyone. Cryptocurrencies are taxable in most jurisdictions, and although it’s a difficult process to file, everyone should plan to pay taxes.
If you live in the United States, as the Reddit poster here does, it might be worthwhile to HODL through the massive drawdowns. In the United States, traders are rewarded for holding positions for more than a year by qualifying for “long-term capital gains” taxes. Normally, trades and investments are taxed as ordinary income, which means traders pay somewhere between 10-39.6% based on their tax bracket. Investments that fall under the “long-term” qualification are only taxed at 0-20%, and most people (who make $38,601-$425,800) only pay 15% on long-term capital gains.
This represents a huge discount, but also explains why the anonymous poster is in so much trouble. If he booked $800,000 in profits, and realized them within a year, he would be responsible for short-term capital gains tax. Since he made over $425,800 in income, that means he’ll have to pay 39.6% federal income taxes, or a whopping (estimated) $316,000. The rest of his tax bill, totalling $400,000, could be from state taxes. The user admits to living in California, which has a state income tax of 12%.
Crypto-to-Crypto Trades Taxable
Additionally, it’s possible the poster expected he’d be exempt from taxes by sticking to “crypto-to-crypto” trades. In the past, traders reasoned that they could defer taxes by avoiding cashing out to fiat. Under the “like-kind exchange” exemptions, traders can avoid taxes by selling an asset and using the profits to buy something that’s “like-kind.” Commonly used in real estate, many cryptocurrency traders applied this to crypto, too.
However, as of the 2017 tax reform bill, cryptocurrency trades are no longer allowed under “like-kind exchange.” This means anytime you swap BTC for ETH, this is considered a “sale,” and any change in the price of BTC is a realized gain. This presents an accounting nightmare, and shows why traders should actively prepare for taxes - either by hiring a CPA or using software like CoinTracking.