This article is part of TokenTax's Cryptocurrency Tax Guide.
Note that portions of this article were originally published by TokenTax writers in Bloomberg INDG
What is crypto margin trading?
Margin trading is when you borrow money from either the exchange or from other exchange users in order to trade larger positions, with the ability to go long or short. You are tax liable for any gains you make while margin trading and on any interest you earn for lending to a margin pool, such as you would with Bitfinex.
Crypto margin trading taxes in the United States
If you’ve ridden into the depths of margin exchanges like Bitmex, then you’re probably wondering how to handle your taxes. If you lose assets in a margin call or liquidation, those detract from your margin profits. Crypto lost in margin trading either via closing a position at a loss or a margin call / liquidation is treated as a sale, meaning you recognize any capital gain or loss on that crypto.
Popular trading cryptocurrency exchanges that we support include Bitmex, Deribit, Bybit, Bitfinex, Kraken, and Poloniex. Although the IRS has not specifically given guidelines on margin trading, we can take some pointers from existing guidelines.
What are the existing IRS guidelines related to margin trading?
The IRS broadly provides guidance that crypto is to be considered as property for tax purposes in line with Notice 2014-21. Capital gain and loss tax treatment is further described in IRS Publication 544 (Sales and Other Dispositions of Assets) and IRS Publication 551, Basis of Assets.
However, more specific to margin trading, the IRS released Questions and Answers on a series of related crypto trading topics in 2019.IRS Q&A 4 confirms that you recognize capital gains and losses on the sale of crypto assets, subject to the same capital loss deduction limits as other property in Publication 544. For margin trading, this suggests that the relevant values for your tax liability are your net capital profits.
Additionally, IRS Q&A 15 extends their response to exchanges of virtual currency for any other form of property, and IRS Q&A 18 extends their response to include the reverse scenario of property exchanged for virtual currency.
IRS Q&A 20 clarifies that your cost basis for the virtual currency you acquired is the “fair market value of the virtual currency, in U.S. dollars, when the virtual currency is received.” For margin trading, these answers again suggest that the relevant values for your tax liability are your net capital profits. Additionally, the IRS Q&A 39 clarifies that specific identification of your tax lots is acceptable, allowing tax loss harvesting and minimization accounting methods.
What are the challenges with margin trading taxes?
While applying the IRS rules directly to margin trading is somewhat of a grey area, the IRS treatment of cryptocurrency as property has been consistent. Most of the tax rules for crypto are well in line with other tradable assets.
A common issue with taxes on cryptocurrency margin trading is getting all of the data from exchanges in order to report the transactions accurately. The process often requires contacting the exchange and asking for custom information not normally provided in their standard historical data download. Different exchanges store the transaction information differently, and there are complexities in linking the information if the opening and closing long or short positions are stored in aggregate.
Ideally, what information would be used to calculate margin taxes?
If you keep in mind that you are broadly subject to capital gains taxes when you trade margin, it is easier to understand your taxable events. To better understand how these rules could apply to margin trading, it makes sense to think about how to pay taxes if you are a trader separately from as if you are a lender.
Margin trading results in capital gains and losses to be reported on Form 8949
For margin traders on Binance, Kraken or another platform, the cryptocurrency gains or losses from the leveraged transactions should be reported on IRS Form 8949.
In a simplified example, if User A buys 10 Binance Coins (BNB) using two times leverage and the price of BNB increases, the capital gains are taxable when the position is exchanged for another cryptocurrency or for fiat currency. If User A trades the 20 BNB for bitcoin (BTC), the 20 BNB is taxed at the U.S. dollar value at the time of the transaction.
The example trades above are problematic because the user had only bought 10 BNB and is now selling 20 BNB. In other words, the trader is now short BNB. This is one of the biggest complexities with margin trading. Eventually, the user will close the position by buying back BNB.
The gain or loss on the BNB should be the difference between the sale and subsequent re-purchase of the same cryptocurrency. The gain or loss will need to be calculated the same way (but separately on the BTC that was bought and eventually sold). The borrowing expense also needs to be accounted for in the tax calculations.
Interest earned from margin lending is more similar to IRS tax treatment of as ordinary income reported on Form 1040
For cryptocurrency holders lending to margin trading platforms like Bitfinex in exchange for interest, the interest earned needs to be reported as income. If that interest is paid out as cryptocurrency then that income becomes the cost basis when it is sold.
Consider the tax implications of the following example: If User A lends 10 lots of BNB or 100 BNB total, they earn BNB × 10 in interest, or 0.57534 BNB. The 0.57534 BNB earned is taxable income. When it is exchanged for another cryptocurrency or for fiat currency, the gain or loss will be calculated as the difference between the sale proceeds and this taxable income.
If User A trades the 0.57534 BNB for BTC, the 0.57534 BNB is taxed at the U.S. dollar value at the time of the transaction. If User A holds the 0.57534 BNB interest without trading it for another cryptocurrency or for fiat the entire tax year before selling it, any gain would be taxed at the preferable long-term capital gain rate.
Where can I go if I need more help with cryptocurrency taxes on margin trades?
If you are trading on margin, you most likely are an advanced day trader or investment fund with an extensive trade volume. If you are not already using crypto tax software, it would likely make your tax reporting much easier. With software, your information is automatically organized, and the program automatically generates your aggregate capital gains and losses.
For more complex tax situations, crypto CPAs and accounting experts would also provide you with guidance on tax laws, best practices and support if you are audited. Although the IRS has not explicitly given guidance on margin trading, their Q&As are consistent about tax rates on crypto assets.