How to Report Crypto Margin Trades On Your Tax Return
What is margin trading?
When you trade cryptocurrency on margin, you borrow money from exchanges or other brokers to carry out trades. Margin trading can potentially amplify your gains and losses from cryptocurrency trades.
To better understand the concept of margin trading, imagine that you have 1 ETH worth $3,000. If you are using an exchange that offers 3x leverage, you can use your ETH as collateral to borrow up to $9,000.
However, if you lose money on a trade and you no longer meet the platform’s minimum margin trading requirements, your collateral could be liquidated.
How is margin trading taxed?
At this time, the IRS has not issued specific guidance on how crypto margin trading is taxed. However, we can infer the tax implications based on the taxation of similar asset classes such as equities.
It’s expected that the profits and losses generated from margin trading are reportable as capital gains and losses, similar to other cryptocurrency disposals.
Remember, you can calculate capital gains and losses using this formula.
Determining your gross proceeds and cost basis on a margin trade on your tax return differs depending on whether you made a gain or a loss on the transaction.
How can I calculate and report my margin trading gains?
If you make a profit on a margin trade, you should report this as a capital gain. Let’s take a look at an example to better understand how this works.
Example: Gains from margin trading
Using leverage, Kyle borrows $5,000 of ETH.
He pays $200 of interest payments related to borrowing this crypto.
Kyle sells his ETH at $10,000.
In this case, Kyle has $5,000 of net profit ($10,000 - $5,000). In this case, Kyle should report $5,000 of gross proceeds. Because the gain came from borrowed funds, Kyle would report any gain by showing $0 of basis.
Kyle can report the $200 of interest payments as an investment interest expense on Form 4952, Investment Interest Expense Deduction. To claim the deduction, Kyle should report the deductible amount on Schedule A.
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How do I calculate and report margin trading losses?
If you lose money on a margin trade, you should report this as a capital loss. Let’s take a look at another example.
Example: Margin trading losses
Lyanna borrows Bitcoin at $2,000.
The price of her coins falls to $1,500.
Lyanna sells her Bitcoin and closes her position.
In this case, Lyanna’s gross proceeds are equal to $0, since she realized no profit on the transaction. In order to report the loss from trading with borrowed funds, Lyanna reports $0 of proceeds and a cost basis equal to her net loss on the transaction, $500 ($2,000 - $1,500).
How do I calculate gains and losses on a short position?
If you’ve taken a short position using margin, you can calculate your gains and losses using the same methods outlined above.
Example: Short position tax
Ann uses margin to short Ethereum. She borrows 1 ETH and sells it for $2,000.
The price of Ethereum rises to $2,500.
To limit her loss, Ann buys Ethereum and returns it to close her position.
Ann reports a loss of $500 on her taxes.
In this example, Ann’s has a loss of $500 ($2,000-$2,500). She reports gross proceeds equal to $0 and cost basis equal to her net loss on the transaction, $500.
How are liquidations taxed?
If you fall under an exchange’s minimum requirements for margin trading, it’s possible that your collateral will be liquidated to cover the exchange’s costs. Margin trading liquidations are considered a taxable event subject to capital gains tax.
Even if you do not receive the proceeds of the liquidation, you’ll still incur a capital gain or loss based on how the price of the liquidated collateral has changed since you originally received it.
Example: Liquidation tax
Julie uses 1 ETH as collateral to take out leverage.
Julie’s original cost of buying ETH was $2,500.
The value of Julie’s ETH drops to $1,500.
Julie’s ETH is liquidated.
Julie incurs a capital loss of $1,000.
What are crypto derivatives?
A crypto derivative is a contract that derives value from the prices of underlying cryptocurrencies such as Bitcoin and Ethereum.
For example, traders who believe that the price of Bitcoin will go up can buy Bitcoin futures contracts, a type of derivative. This contract gives them the right to buy Bitcoin on a future date at a predetermined price.
How are crypto derivatives taxed?
The IRS has not put out explicit guidance on how crypto derivatives are taxed. However, it’s likely that derivative taxation rules that apply to equities will also apply to cryptocurrencies.
According to Section 1256 of the Internal Revenue Code, gains from regulated futures will be considered 60% long-term capital gains and 40% short-term capital gains, regardless of how long the trade was open.
It’s likely that crypto futures traded on derivative marketplaces like CME Group will be subject to these same rules.
However, it’s unclear whether crypto futures traded on DeFi exchanges will be considered ‘regulated futures’. If you have specific questions on how your derivative trading activity will be taxed, you should consult your tax professional.
What records should I keep for margin trading and crypto derivatives?
Margin trades and crypto derivatives should be reported on Form 8949, along with any other capital gains and losses you may have in a given year. You’ll need to provide the following information:
The type and amount of cryptocurrency you disposed of
The date you originally acquired the cryptocurrency
The date you sold or disposed of the cryptocurrency
Gross proceeds from the disposal
Your cost basis for acquiring your cryptocurrency
Your gain or loss
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