Cryptocurrencies are taking the financial world by storm and leaving a lot of Canadian investors confused about the correct way to report their crypto on their Canadian Tax returns. The CRA treats cryptocurrencies as a commodity and not a currency, and as such crypto is subject to capital gains tax (read the CRA guide). To muddy the waters further- US crypto tax rules are very different from Canadian ones so investors need to be careful what advice they heed online.
This blog post focuses on the topic of capital gains and will outline the top 5 tax considerations you need to take into account when determining whether or not your crypto activity is subject to capital gains tax in Canada. For an introduction to crypto and Canadian tax read my previous blog.
What are realized vs. unrealized capital gains?
What is considered a taxable event by the CRA?
Why timing is key in planning your crypto transactions?
How to calculate capital gains on your cryptocurrency activity?
How do I calculate crypto losses?
1. Realized vs. Unrealized
Because the CRA views cryptocurrency as a commodity and not a currency, they only count “realized” gains or losses when it comes to tax compliance.
So what does it mean for an asset to have a “realized” gain?
Let’s illustrate this with a simple example.
Meet our imaginary investor Bob.
In 2020 Bob purchased $20K CAD worth of Bitcoin. It’s 2021 and Bob’s coin has grown to 60K CAD. Now Bob has in theory gained 40K and the question is- will he have to pay capital gains on this amount? If Bob decides to “do nothing” with his asset (sell, trade or otherwise convert it) his gain is considered a “paper gain” and remains “unrealized” in the eyes of the CRA, which means Bob doesn’t have to report or pay taxes on this asset on his 2021 tax return.
Now, if Bob decided to sell or trade his asset this would trigger a “taxable event” and he would be required to report and pay the appropriate tax. This brings us to our next point…
2. Taxable events
As I mentioned in the above section, if you just hold a crypto asset and “do” nothing with it, there would be no “realized” gains or losses no matter what happens to the market price of that token. And as such, there would be no “taxable event” and therefore no Canadian taxes owed.
So what is considered a taxable event in the eyes of the CRA?
Sale for fiat
One of the most common “taxable events” is sale of crypto for fiat (or regular currency such as USD, CAD etc..)
Let’s go back to Bob.
Let’s imagine that in December of 2021, Bob decided to sell the Bitcoin for fiat and received $60K CAD for it. Since he purchased the BTC back in 2020 for $20K CAD, he has now realized a gain of $40,000 CAD. This gain is something that Bob would have to report on his income tax return and pay tax.
This example is pretty black and white -
Unrealized = hold a crypto-> no realized gain-> no taxable event->no tax
Realized = sell a crypto for fiat -> realized gain-> taxable event-> report and pay tax
There are however some less obvious transactions that trigger “taxable events” in the eyes of the CRA.
The two most common are: when you trade one crypto currency for another; and where you use a crypto currency to buy goods or services.
Exchange for another cryptocurrency
Let’s consider another scenario. Instead of selling his BTC for fiat, Bob decided to swap it for Ethereum. Since Bob got rid of the Bitcoin, for Canadian tax purposes he is said to have disposed of the asset he previously held, and that is a taxable event. Now in this case Bob didn’t get any Canadian dollars for the BTC (or any other fiat for that matter), so the calculation of his realized gain is slightly more tricky (that’s another topic we will cover later).
Use to buy goods or services
What if Bob used his Bitcoin to ”pay” for something else let’s say- professional accounting services? The scare quotes around “pay” are intentional by the way. Since the CRA does not see crypto as a currency, when it's used to acquire a service or a good, CRA treated this type of transaction as a kind of barter. Because Bob disposed of his BTC-in the eyes of the CRA, a taxable event is triggered. And although Bob never saw any dollars (read fiat) in the process, he would still need to calculate any gain, report it on his tax return and pay the tax.
There are other transactions that are considered taxable events which are less straightforward. For example, transfers of a crypto token from one wallet or exchange to another is usually not a taxable event, BUT transfers into and out of aTokens, cToken and liquidity pools might be.
Other less common grey areas are loss of crypto due to hacks and donating a digital currency to a charity. Such less common transactions need to be analyzed case by case to determine what the most appropriate tax treatment would be.
3. Timing is key
Since only realized gains get taxed in Canada, the timing of the taxable event becomes very important.
In our example Bob sold his BTC in December of 2021. Since the gain is realized in 2021 he will have to report it on his 2021 tax return and pay tax on it before the payment deadline for 2021 (normally April 30th of 2022).
Knowing that a taxable event will be triggered, it is important to plan your transactions to optimize your taxes.
If Bob had waited until January 1st, 2022 to make the sale, the gain would not be realized until 2022, so he would not need to report it on his 2021 return. The gain would only be reported and taxed on his 2022 return, due in early 2023.
The decision to hold or sell a crypto asset around the turn of a new year can make a significant difference on your taxes.
4. How to calculate capital gains on your cryptocurrency activity?
When Bob sold his Bitcoin that he had bought for $20K CAD for $60K CAD, we calculated his gain at $40,000
(sale price of $60K minus his original purchase price of $20K)
This is a very simplistic example. The complications arise because oftentimes one or both of these two numbers (original cost + proceeds) are less obvious.
In one of the scenarios Bob swapped his Bitcoin for some ETH instead of cashing it out for fiat. Since there was no CAD involved in the exchange, his proceeds of sale will need to be determined some other way. The CRA considers this swap a type of a barter transaction, so the sale price of the Bitcoin will be the value of the ETH Bob received in exchange.
Again for illustration purposes and to keep it simple, let’s say Bob got 10 ETH for his 1 BTC when he made the swap in December of 2021. His sale price would be based on the value of those 10 ETH.
But if Bob is preparing his tax return in April 2022, he can’t just look up the current price of ETH. He’ll have to look back to what those 10 ETH were worth when he made the exchange back in December. Again, timing is key as is accurate pricing data. If the tax authorities decide to review the tax return 3 years down the road, Bob will need to provide them with documentation to support the valuation of the ETH he used to calculate his reported gain.
So let’s say the price of ETH at the time of his exchange was CAD $6,000. So the value of the 10 ETH he received would have been $60K. That would be his proceeds of sale. So again, his gain would be $40K (the $60K minus his original price of $20K that he paid for the Bitcoin back in 2020).
You might be thinking- what if Bob used the BTC to pay for professional services? Since, again, this is a type of barter in CRA’s eyes, we’d technically need to report the transaction at the value of the products and services he received, at the time he received them.
This is not a very common scenario yet, but as more and more vendors and private individuals are moving to accept cryptocurrencies it will become a common tax reality quickly.
The other part of the gain equation - the original cost - can present challenges as well.
In our simple example Bob bought his Bitcoin with fiat currency in a single transaction back in 2020, so the cost is simple enough to peg at $20K CAD.
But if a digital asset is acquired in some other way rather than a straight purchase with cash, we can be facing some of the same issues as we saw with the sales price.
For example, let’s revisit one of the scenarios - the one where Bob had swapped his 1 BTC for 10 ETH.
What if one year later in December 2022 he turned around and sold those 10 ETH for $80K CAD? His sale price is $80K CAD right?
But what is the cost of the Etherium? Well he acquired them in an exchange so as far as the CRA is concerned, his cost would be the value of what he gave up to get them. In other words, Bob would need to go back and get the value of 1 BTC at the time he made the swap for ETH back in December 2021. If the Bitcoin was worth $60K, then that’s his cost, meaning that his realized gain on the sale of the Ethereum in 2022 would be $20K (i.e., 80K less the 60K).
In reality, investors rarely acquire their pools of digital assets in a single clean transaction at one simple unit price. A more realistic scenario would be if Bob bought 1 BTC in 2017 for $6,000, another in 2019 for $10,000, another in early for $20,000.
So what happens if he then sells one of these 3 Bitcoins in December 2021 for $60K CAD? His selling price is $60K but what about the cost? This is where things get interesting. And it is also where the Canadian and US rules diverge widely.
A bit of background on the IRS approach…
The US tax authorities (IRS), will allow one of two methods to determine the cost. First-in-first-out (or “FIFO” for short) would require that Bob use the cost of the earliest Bitcoin acquired at the cost of his first Bitcoin sold (i.e. he would use the $6K). The other method the IRS accepts is called Specific Identification, which would require Bob to track each separate digital asset unit separately.
In Canada, however, you are not permitted to use either of these methods.
For the CRA, the only acceptable method is Weighted Average. This is where you determine the average per unit cost of the total pool of a given crypto currency. This makes logical sense if we recall that the Canadian tax system sees digital currencies as a type of commodity. As a commodity, we do not differentiate between one Bitcoin and another, or track their specific cost separately. We just average them.
So back to our example, Bob spent $36K CAD buying his 3 BTC over time so his weighted average cost per unit is $12K CAD. When he sells that one BTC in 2021, the cost he’ll report will be $12K CAD, resulting in a capital gain of $48K CAD. Consider that if he applied the FIFO method his gains would be 54K (i.e. 60K - 6K). So be careful when taking tax tips from fellow investors south of the border.
5. How do I calculate cryptocurrency losses?
Losses are part of the investment game. When they do happen it’s important to understand how this affects your taxes in Canada and how to make the most of the downside.
Flip coin to gains
In most respects, crypto losses work much the same as crypto gains. The same types of taxable events trigger realized losses. Both are calculated using the same approach (sales proceeds minus original cost). The issues that can arise with determining proceeds and costs in calculating gains are also present when we have losses. Think off it as the other side of the same coin (no pun intended).
Deducting losses from gains
The “upside” to losses (if there can be one) is that they can offset your gains. Remember how Bob sold his 1 Bitcoin in December 2021 and realized a $40K CAD gain? Well imagine that Bob also sold 20 Ethereum coins for $82K CAD in December after buying them just a month earlier at $92K CAD. This transaction resulted in a realized loss of $10K CAD. Bob can offset his gain on the Bitcoin with the loss on the ETH, and report the net gain of $30K CAD, paying taxes only on this amount.
Some limitations to watch for
Unfortunately there are times when the losses cannot be deducted.
For instance, if Bob had sold the ETH at a loss as in our scenario above, but did not have any realized gains, he couldn’t take a deduction for the loss on the ETH. The good news is that the loss could be offset by gains realized in other years, so it’s not entirely wasted.
There is, however, a scenario where the CRA can deny any deduction for a call altogether. This is where an investor sells a digital asset at a loss and then soon after buys the same currency again. Depending on the timing of the two transactions, the tax authorities may not let the investor claim the loss on the original sale. Again, timing is key here.
Some parting tips...
Timing is key: since only realized gains and losses matter for tax in Canada, when the sale occurs can make a big difference on your tax return.
Good data is crucial: having reliable and supportable pricing data on your crypto currencies will not only help you calculate your gains and losses correctly, but will enable you to defend your numbers in case of a tax audit.
Rely on local advice: there are significant differences between how crypto gains are taxed in Canada compared to the US (or other other countries). Find a tax advisor that knows how to deal in this space.
Each tax situation is completely different and as such your crypto tax advisor needs to take a holistic approach when assessing and planning your investment.
About the author: Yuriy Lozynsky is a CPA and the founder of Deixis, a Canadian accounting firm specializing in crypto currency tax compliance.
The information provided in this blog is general in nature and solely for educational purposes. Viewers use and implementation of the information comes at their own risk and is their own responsibility.