The latest developments around capital gains taxes may have a favorable impact for cryptocurrency users. Capital gains taxes have been one of the most hotly debated topics in the tax code for a number of years. Prior to COVID-19, there were some murmurs from the Trump Administration about changing the way we calculate capital gain taxes as a part of the Tax Cuts & Jobs Act (TCJA) 2.0. This topic is also gaining momentum because several media outlets recently reported that the 4th Coronavirus stimulus package could include provisions to reduce capital gains taxes. If passed, this could have significant consequences for tax savings on your cryptocurrency transactions. This post discusses how these proposed reforms would work and how they could potentially reduce your cryptocurrency capital gains taxes, if/when implemented.
The Current Capital Gains Tax Regime
Currently, cryptocurrency capital gains do not account for inflation. For example, assume Jennet purchased 1 bitcoin (BTC) in 2010 for $1,000 (cost basis) and sold that coin in 2018 for $10,000 (proceeds). This would trigger $9,000 ($10,000 – $1,000) of long term capital gains and an estimated $1,350 ($9,000 * 15%) of capital gains tax. Pretty straightforward.
Note however that there is a subtle flaw in the calculation above: it doesn’t account for inflation. The cost basis ($1,000) is in 2013 dollars which now have less buying power in 2018 due to inflation. Therefore, the resulting capital gain and taxes are overstated in 2018 dollars.
Accounting For Inflation
One potential remedy for this issue is indexing the cost basis for inflation. In simple terms, this adjusts cost basis upwards for inflation to the year of the disposal of the asset. Continuing with the example above, let’s assume the inflation rate is 20% over the period from 2013 to 2018. In this case, the cost basis used to calculate the capital gains will be $1,200 ($1,000 * 1.2). This will result in $8,800 ($10,000 – $1,200) of capital gains which is lower than the one we calculated without taking inflation into consideration. This will also result in a lower tax bill: $1,320 ($8,800 * 15%) compared to $1,350. As you can see, adjusting the cost basis for inflation would result in a more equitable capital gain tax calculation and lead to lower overall capital gain taxes (assuming positive inflation over your holding period).
It is yet to be determined if capital gains taxes will be updated to allow cost basis indexing via the 4th stimulus bill. However, since this method has been discussed in the past, the likelihood of following this approach seems very likely. If passed, this new approach could help stimulate the economy by helping individuals keep more investment income in their pockets and rectify the long standing inflation gap in calculating capital gains taxes.
Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.