How to handle cryptocurrency on tax returns

The U.S. Internal Revenue Service (IRS) is further along in both guidance and reporting requirements, said John Oakey, vice-president of taxation with CPA Canada in Dartmouth, N.S.

Since 2020 the IRS has asked individual tax filers on Form 1040 whether they received or sold virtual currency, and the agency added the same question to its estate, trust, partnership and corporation returns in 2023.

The CRA does not include a similar question on its tax returns, but told Investment Executive that it began updating its paperwork during the 2022 tax season to include guidance on the reporting of cryptoasset gains and losses.

The CRA “continues to explore cryptoasset reporting obligations through assessment of its current tax forms,” spokesperson Aaron Martin stated in an email.

The CRA also provides ongoing guidance to taxpayers on a webpage with information about cryptoassets and via tax interpretations.

How crypto is taxed

For tax purposes, the CRA views cryptocurrency as a commodity, not a currency. When cryptocurrency is used to pay for goods and services, the CRA considers that a barter transaction.

Just holding cryptocurrency does not result in a taxable event. However, giving, using, selling or exchanging cryptocurrency is considered a disposition for tax purposes, resulting in either business income or capital gains, depending on the situation.

In the CRA’s view, a taxpayer has disposed of cryptocurrency if they use it to pay for goods or services. The vendor must include in their income the value of the goods or services or the value of the cryptocurrency accepted, whichever is more readily valued.

Generally, if someone is holding cryptocurrency as a long-term investment, the income from the transaction is considered a gain; if they are holding it as inventory, the income is taxed as business income.

The question of whether profits earned (or losses incurred) in a crypto transaction are taxed as business income or a capital gain can be complex, but is generally no different than the one facing taxpayers who sell or trade other securities, Oakey said: “That’s the easy part [of cryptocurrency taxation] to understand.”

More complex is the tax treatment of crypto mining, which creates cryptocurrency. The receipt of cryptocurrency by miners from successfully validating cryptocurrency transactions is deemed business income at the time of receipt. What cryptocurrency miners do with the cryptocurrency they receive — hold it for long-term investment or actively trade it — determines its treatment as business income or capital gains.

Canadian mutual funds and ETFs that invest in cryptocurrency are subject to the same taxation rules as other mutual funds and ETFs. As for U.S. bitcoin ETFs, tax experts declined to speculate on tax treatment given that the products’ structure is so new.

Finally, the CRA has issued little or no guidance on what Oakey calls “weird transactions.” These include “forks,” which is when a new cryptocurrency is created or split out of an existing cryptocurrency; and “airdrops,” which occur when a cryptocurrency platform deposits free crypto tokens to a holder’s wallet, often to promote a new token.

In contrast, the IRS has issued positions on both forks and airdrops.

Another lingering issue for Canadian crypto holders and tax professionals is whether cryptocurrency is considered specified foreign property. Foreign property in non-registered accounts with a total cost of more than $100,000 must be reported annually on Form T1135. Failure to file can result in big penalties.

The CRA has stated that cryptocurrency may need to be reported on Form T1135, depending on where the assets are situated, deposited or held. The CRA told CPA Canada late last year that cryptocurrency typically won’t be considered situated, deposited or held outside Canada if held through a Canadian-resident crypto-trading platform that complies with Canadian regulations.

This decision “makes life a bit easier” for Canadian investors using the platforms, said Noah Billick, partner and director of regulatory, funds and compliance with Renno & Co., a law firm based in Montreal.

However, Oakey said taxpayers still don’t have clear guidance on how to determine the status of cryptocurrency held on a non-Canadian crypto platform: “Cryptocurrency is everywhere and nowhere. It is stored as binary code on thousands of computers across the world.”

Rotfleisch said he believes cryptocurrency should always be reported on Form T1135. “There’s absolutely zero downside to including something that may or may not be [foreign property] and there is lots of downside to excluding something [that is].”

The CRA “does not currently track cryptoasset declarations separately in its system,” Martin wrote. Instead, the agency “relies on a number of internal and external data tools to identify Canadian taxpayers and registrants involved in cryptoassets and detect transactions.” This includes acquiring licences to blockchain analytical tools and obtaining information from third parties.

Oakey said he believes the CRA will eventually require more detailed reporting of cryptocurrency. Canada, along with about 50 other countries, issued a joint statement in November committing to work toward a cryptoasset information-sharing agreement by 2027.

Martin said the CRA “will be working toward planning for the domestic implementation of the framework targeting first domestic filings and exchanges in 2027 for the 2026 calendar year.”

This article appears in the February issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.